When you take out a loan for your mortgage, you will come across two types of mortgage loan types – fixed and adjustable. Each of the two has its advantages and knowing which one to go for, based on your financial situation, will prove highly beneficial long term.
In simple terms, fixed-rate mortgages maintain the same interest rate throughout the entirety of the borrowing period. Adjustable-Rate Mortgages (ARMs) have interest rates that may rise or fall after some time based on how the economy is performing.
Fixed-rate mortgages are easier to predict and also make it easier for borrowers to plan out their finances. However, Adjustable-Rate Mortgages have a chance of increasing or decreasing over time, which makes them an excellent choice for borrowers who see interest rates declining over time.
If you’re still undecided as to which mortgage loan type is right for you, let’s take a closer look at each of the two.
What is a Fixed-Rate Mortgage?
In a fixed-rate mortgage, the interest rate stays the same throughout the entire borrowing period. With these mortgages, the principal and interest paid each month varies, but the total payment will always remain the same.
Fixed-rate mortgages can protect buyers from increases in monthly payments if interest rates rise. However, buyers should note that while interest rates will stay the same, the total amount of interest you’ll pay depends on your mortgage term. Typically, buyers choose between 10,15, and 30-year terms when deciding on their mortgage.
Pros of a Fixed-Rate Mortgage:
- Consistent interest rate throughout the borrowing period
- Easier for borrowers to plan finances
- The simpler choice for homeowners
Cons of a Fixed-Rate Mortgage:
- It can be hard to apply for a loan when interest rates are high
When Should You Opt for a Fixed-Rate Mortgage?
Any home buyer who wants to plan their finances over the long term would be better off with a fixed-rate mortgage. If the market has low interest rates, fixed-rate mortgages can offer a wide range of benefits. And since fixed-rate mortgages are much more straightforward, it will be easier for homeowners to apply and understand the terms of their mortgage.
What is an Adjustable-Rate Mortgage?
As the name suggests, Adjustable Rate Mortgages have interest rates that may vary over time. The initial interest rate for these mortgages will be set below what you’ll find on a comparable fixed-rate mortgage.
When applying for an ARM, borrowers will face a fixed set of time where the interest rate remains the same. After the initial fixed interest rate term expires, the Interest rates are adjusted based on the current market’s interest rates.
The new rate will remain the same until the term expires again. If the interest rates of the current market go down over time, so will the interest rate on your mortgage. However, if interest rates go up, you will end up having to pay more.
When opting for an ARM, buyers are encouraged to plan out the worst-case scenarios. And if you can afford the cost of paying the fees if interest rates go up over time, then it will be worth the gamble.
Pros of an Adjustable-Rate Mortgage:
- Interest rates may go lower over time depending on the market
- More affordable than a fixed-rate mortgage for the first couple of years
- Lower initial payments
- Easier for buyers to qualify for larger loans
Cons of an Adjustable-Rate Mortgage:
- Interest rates may rise over time
- Some loans are structured in a way that interest rates may double after a couple of years
When Should You Opt for an Adjustable-Rate Mortgage?
Short-term homeowners and those who expect their salary to increase over time may benefit from an ARM. If you are uncertain about your finances, then this type of loan may end up costing you a lot more than you can afford to pay 5 or 10 years from now.
Both fixed and adjusted rate mortgages have their pros and cons. You should go for the one that makes the most for your financial situation now and in the future. It might be best to consider a mortgage broker like Breezeful to help you choose the right one. Do bear in mind that while fixed-rate mortgages can be harder to get, ARMs may end up costing you more money at the end of your mortgage term than you initially anticipated.