Wondering why you should care about the fixed-rate vs. adjustable-rate mortgages debate that continues to rage on in the real estate world? Read on to find out!
Are you looking into financing your first home purchase and keep running into conflicting advise around fixed-rate and adjustable rate mortgages? Fixed-rate and adjustable-rate are two categories of mortgages that can be further divided into various more specific categories. The first step you need to take when applying for a mortgage is to determine which one will work best for you based on your varied needs.
So, let’s explore fixed-rate and adjustable-rate mortgages to understand the difference between them and determine which one is better!
Fixed-Rate vs. Adjustable-Rate Mortgages
Here’s an overview of both mortgage types to help you make an easy decision:
A fixed-rate mortgage charges a defined interest rate that remains unchanged during the loan lifetime. Even though the amount of principal and interest you pay every month can vary, the total payment you will need to pay will remain the same, making future budgeting easier.
The significant benefit of a fixed-rate mortgage is that you remain protected from the sudden and often significant spike in monthly mortgage payments that depend on interest rate spikes. Moreover, these mortgages are easier to understand as they vary very little from lender to lender.
However, the downside of these mortgages is that when the interest rates are higher, qualifying for a fixed-rate mortgage becomes difficult since the payments are less affordable. You can use a mortgage calculator to measure the impact of varied rates on your monthly payments by entering your home price, down payment, property tax, loan term, homeowner’s insurance, and credit score.
Moreover, even though the interest rate is fixed in fixed-rate mortgages, the amount of interest you pay will depend on your mortgage term. Traditional lenders offer fixed-rate mortgages for varying terms, including the standard 15-, 20-, and 30 year-terms. The last is the most popular choice since it requires the lowest monthly payments. But you will have to pay a significantly higher total cost over the life of your loan due to the lower monthly payment.
On the flip side, shorter-term mortgages have higher monthly payments but lower interest rates, which ensures that you can pay a large amount of principal with each payment. So, these shorter-term loans cost less in the long run if you can afford the higher monthly payments.
Adjustable-rate mortgages have varying interest rates. The initial rate on such a mortgage is set below the market rate, but the rate rises with time. If you hold the adjustable-rate mortgage for a long time, the interest rate will surpass the going rate for fixed-rate loans. Moreover, these loans have a fixed time during which the initial rate remains constant, after which it continues to adjust at a pre-determined frequency.
The fixed-rate period can vary greatly; it can be as short as a month or as long as ten years. Shorter adjustment periods typically carry lower initial rates. However, the loan will reset after the initial term, requiring you to pay the current market rate, which will remain your rate until the next reset period.
In the fixed-rate vs. adjustable-rate mortgages debate, the latter is significantly more complex as they have varying terminologies, such as adjustment frequency, indexes, ceilings, margins, caps, and more. However, they also offer a significant benefit compared to fixed-rate loans. The initial payments that can easily last for the first three to seven years are considerably less than the payments of a fixed-rate mortgage.
The lower initial payments enable you to qualify for a bigger loan while also enjoying a lower interest rate when the interest rates are lowering. If you choose an ARM, you can benefit from saving several hundred dollars a month for up to seven years, after which your costs will rise. The market rate will determine the new rate at that time. If you’re lucky, that rate might be lower than the market rate at the time you closed the loan.
With that said, an adjustable-mortgage rate has its fair share of downsides. Your monthly payment might frequently change, making budgeting difficult. Plus, if you choose a large loan, you could get stuck with a high-interest rate down the line, which you might inflate your monthly payments beyond your means. Even though it offers many advantages upfront, these downsides can make adjustable-interest mortgages a disaster if you aren’t aware and prepared for the possible changes to your payments.
Which Loan Should You Choose?
When choosing a mortgage type, you need to consider various factors, including your finances, the rise and fall of interest rates, your credit history, your ability to afford an ARM in the future, your plans for living on your property, and more. If you’re considering an adjustable-rate mortgage, you should consider if you can afford the mortgage when the rate resets to the maximum cap. You can devise a strategy to save the money an ARM enables you to save in the initial years to pay off the extra principal payments later.
An ARM is an excellent choice for you if you don’t plan to own your property for long. You can enjoy the low payments in the near term. But if you want to live in your house for a long time, a fixed rate might be a better choice for you. Moreover, if you have a stable income that might not increase drastically, you will benefit from a fixed-rate mortgage. On the flip side, if you expect your financial condition to improve with time, you can choose an ARM.
Lastly, if you think you will be able to generate the money needed to pay off the loan before the new interest rate kicks in, an adjustable-rate might be your best bet. It’s best for individuals who want to sell their current home and buy a new one. You can take out a short ARM loan while waiting for the old one’s contract to go up, and when it does, you can sell that house and use the money to pay off your ARM during the lower payment period.
Regardless of the loan you choose, you need to conduct proper research to make the right choice. Integrity Mortgage NMLS #1692497 can offer you the right loan depending on your distinctive needs. Reach out to us today!