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Fixed Rate Mortgage vs Adjustable Rate Mortgage
If you are planning to purchase a new home or refinance your existing mortgage, there are always two basic options available, a fixed rate mortgage and an adjustable rate mortgage.
In this post, we will compare fixed rate mortgage Vs. adjustable rate mortgage and their pros and cons that will help you know which one is better for you.
What Is A Fixed Rate Mortgage?
A fixed rate mortgage is a fixed term, meaning the interest rates are fixed, the term is fixed, and no changes.
You will agree to a certain term, you agree to a certain percentage amount which will not change within your loan tenure no matter if the rates go up or down, you are locked in.
The fixed rate mortgage is the most preferred product for most of the borrowers and homeowners because there is less of the risk involved for the payments to rise.
Pros Of A Fixed Rate Mortgage
1) Payment Predictability: Your mortgage will remain the same even though payment fluctuation to your servicer may change.
2) Ease of paying Down Principal: Most fixed rate mortgages do not come with overly restrictive prepayment penalties so that you can make extra payments towards your principal without any additional fees.
3) Stable Interest Rates: If the mortgage market significantly worsens, you don’t have to worry about paying more interest. And if it is better, you can refinance to get a better rate.
Cons Of A Fixed Rate Mortgage
1) Expensive Upfront Costs: Closing costs such as origination fees, discount points, and underwriting fees, are often higher than other types of loans.
2) Higher Comparable Interest Rates: If you are not planning to be in the same home for a long period, you can likely get a better interest rate for the time you will be there by choosing the adjustable rate mortgage.
3) Difficult to Qualify: Because the payment is higher and the closing costs greater, those with a low credit score or planning to make a smaller down payment may have difficulty getting a good deal.
What Is An Adjustable Rate Mortgage?
As the name suggests, an adjustable rate mortgage is a loan where the interest rate will change. Usually, in an adjustable rate mortgage, the interest rate is fixed for the first few years like 3, 5, or 7
After the fixed term is up, the interest rate might go up or down depending on where the economy is. Adjustable rates are more dependent on the prime rate, which is the current market interest rate.
So if your prime rate goes up, your interest rate also will go up. If your prime rate goes down, your interest rate will go down. Subsequently, if your rates are going up and down, your mortgage payments are affected based on that.
Pros of An Adjustable Rate Mortgage
1) Low Payments in the Fixed Rate Phase: An adjustable rate mortgage offers potential savings in the initial fixed rate period. Common adjustable rate mortgage terms are 3/1, 5/1, 7/1, and 10/1.
With a 5/1 adjustable rate mortgage, your introductory interest rate is locked in for five years before it can change that gives you five years of predictable low payments.
2) Flexibility: An adjustable rate mortgage could be a good idea if your life is likely to change in the next few years. For instance, if you plan to move or sell the house, you can enjoy the ARM’s fixed rate period and sell before it ends.
3) Rate and Payment Caps: Adjustable rate mortgages may have several types of caps, which limit the increase of your interest rates and the size of your payment.
These include the cap on how much the rate can change each time it adjusts and total rate change over the loan’s lifetime.
4) Your Payment Can Decrease: If interest rates fall and drive down the index against which your adjustable rate mortgage is benchmarked, there is a possibility that your monthly payment could drop.
Cons of An Adjustable Rate Mortgage
1) Your Payment Can Increase: If interest rates are rising, your payments are likely to increase after the adjustable period begins. Some borrowers might have difficulty making the larger payments
2) Things Don’t Go As Planned: The adjustable rate mortgages require borrowers to plan for when the interest rates start changing, and monthly payments may increase.
Even with careful planning, you might be unable to sell or refinance when you want to. If you are unable to make the regular payments after the fixed rate phase of the loan, you could lose the home.
3) Prepayment Penalties: Some ARMs come with prepayment penalties. This is a fee that will be charged if you sell or refinance your home.
If you are planning to sell or refinance your home within the first five years of your mortgage, you should choose a lender who offers you the loan without the prepayment penalty.
Conclusion
Based on your current lifestyle or current situation, you may consider going with a fixed rate mortgage or an adjustable rate mortgage.
It is a perfect conversation to have with your lender and choose what is best for you.
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