Written By Jeffrey Miller - Loan Officer in Rochester Hills
When you are purchasing a home or refinancing an existing mortgage, there are many mortgage options to consider. This includes deciding on a fixed-rate or an adjustable-rate loan. Each option has their respective benefits and in the current rising rate environment of the past six months, the options are less cut and dry and require more consideration than in the recent past.
What is a Fixed-Rate mortgage?
A Fixed-Rate mortgage will have the same interest rate for the entirety of the loan. From your initial to your final payment, the monthly principal and interest portion of the payment will not change. Fixed rates are more common and can typically have a term of 30, 20 or 15 years.
What is an Adjustable-Rate mortgage (also known as an ARM)?
An Adjustable-Rate mortgage offers both a fixed and a variable interest rate component. You pay a fixed interest rate for a pre-established amount of time (usually 5, 7 or 10 years). After the initial fixed rate period, the rate adjusts every six months based on the current rate environment. All rate adjustments are protected by caps that limit the amount the rate can change. Caps apply to both the initial interest rate adjustment as well as the caps for each bi- annual adjustment.
The Pros and Cons of Each
A Fixed-Rate Mortgage has a stable, constant interest rate and payment for the entirety of the loan and is most effective for someone planning to stay in the home for a longer timeframe (10+ years). Fixed mortgages will have a higher interest rate than the initial rate on an Adjustable-Rate Mortgage but offer predictability.
An Adjustable-Rate Mortgage has a lower initial interest rate and payment compared to a Fixed-Rate Mortgage. This allows homeowners who only plan to stay in a home for a short period of time or those expecting rates to decrease in the near future, a lower qualifying payment for the initial fixed period (usually 5,7 or 10 years). After the initial fixed rate period, the rate can increase as it adjusts to current rates. This makes budgeting for other expenses a potential concern.
The Bottom Line:
Both loan options can be effective depending on your individual needs. An Adjustable-Rate is ideal for homebuyers who plan on moving or refinancing within the next few years. If you plan on living long term in your home, don’t mind a higher initial interest rate and desire a consistent payment for budgeting purposes then, a Fixed-Rate would be your best option.