House hunting can be a challenging experience. In addition to finding a home that meets most or all of your needs and wants, there’s always the big question – how will you finance the purchase?
There are two basic loan options
available to borrowers: a fixed rate mortgage and an adjustable rate mortgage, or ARM. Adjustable rate mortgages are also sometimes referred to as variable rate mortgages. Deciding which type of mortgage suits you best will depend on a number of factors.
Fixed rate mortgages
With a fixed rate mortgage, the interest rate remains the same – or fixed – throughout the entire duration of the mortgage. So, if you take out a 30-Year Fixed Rate mortgage, your interest rate will remain the same for 30 years (that is, if you don’t choose to refinance
during that time period). By being locked into a fixed rate mortgage, your rate will stay constant even if mortgage interest rates rise over the course of the loan.
One of the benefits of having a fixed rate mortgage is that you know what to expect as far as your monthly bill is concerned. With your interest rate locked in, your monthly mortgage payment should be the same each month. However, it’s important to note that if you have an escrow account
(in other words, your monthly payment includes the cost of your property taxes and home owners insurance), your monthly payments could still fluctuate over time if your tax bill or insurance premium goes up or down.
Because a fixed rate mortgage allows you to lock in an interest rate for a specified period of time, it can be a solid choice when interest rates are relatively low. However, if you’re looking to buy a home during a time when mortgage rates have just increased sharply, you might want to rethink a lengthy fixed term. That’s because if you lock into a high, fixed interest rate, you could be at a disadvantage if rates decline a few years later. In that case, you would need to refinance your mortgage in order to take advantage of a lower rate, and the process of refinancing can be a major headache for some.
Adjustable Rate or Variable Rate Mortgages
An ARM loan typically starts at a lower interest rate than a fixed rate mortgage, however the interest rate will stay “locked in” for only a limited period of time. The initial low rate could very well stretch into several years, however once the initial period is over, the rate will adjust periodically. A “5/1” ARM loan for example, means that your interest rate will be fixed for 5 years, and then will adjust annually. A “3/3” ARM would have a fixed interest rate for 3 years, and then the rate would adjust every 3 years.
Variable rate mortgages are often appealing to first-time home buyers who only plan to stay in their “starter” home for a few years before selling and purchasing a new home. If you plan to move before the initial rate period is over, you could take advantage of the low initial rate without ever getting hit with the adjusted rate.
While ARM loans can come in handy in the event that interest rates start to fall (in the case of falling rates, ARM borrowers wouldn’t need to refinance in order to take advantage of lower rates; they could just wait for their periodic rate adjustment to kick in and reduce their monthly payment), it’s important to note that there’s always the possibility that rates could climb higher. It’s not uncommon for ARM interest rates to increase several times during a loan’s lifespan. And, if interest rates climb, so do your monthly payments. This could cause a financial strain down the road if multiple consecutive rate hikes cause your mortgage payments to skyrocket.
Another thing to keep in mind about adjustable rate mortgages is that they’re more complicated than fixed rate loans, making it harder for some borrowers to understand how they function. ARM loans are based on such things as caps, margins, and adjustment indexes, and if you’re unfamiliar with these terms and how they impact your loan, it could cause financial headaches for you down the road.
No matter what type of mortgage
seems right for you, it’s always a good idea to meet
with a mortgage professional to discuss your home ownership goals and current financial picture. An experienced mortgage lender
will be able to help you choose the best financing option for your unique situation, and get you into the home of your dreams!