AFCU-logo-2019-white-sm (1)-2
Open an Account
Login
Financial Insight

Choosing the Right Loan: Fixed-Rate vs. Adjustable-Rate Mortgages

If you’ve decided now is the right time for you to invest in a home, it’s also time to decide what type of mortgage works best for your unique situation. The two most popular types of mortgages are fixed-rate and adjustable-rate mortgages. Each mortgage offers positives and negatives for the buyer, so we’ve broken down these pros and cons to help you better understand the difference between a fixed-rate and an adjustable-rate mortgage, and which loan is right for you.

Before we begin, it’s important to know exactly what a mortgage covers in the cost of buying a home. Most buyers pay a percentage, normally 5-25%, of the purchase price of the home upfront, called a down payment. Lenders are more likely to give optimal mortgages to buyers who can afford a down payment, because it shows the lender you’re committed to investing in the home. The mortgage covers the gap between the down payment and the purchase price of the home, not including closing costs. For example, if you’re buying a home for $150,000 with a $10,000 down payment, the mortgage amount would be $140,000.

Fixed-Rate Mortgages

This is the most common type of mortgage in the market. Your monthly payments will stay the same for the entire loan term, whether it is 10, 15, or 30 years. These consistent monthly payments can offer incredible stability, and allow you to accurately budget for the future. However, since you locked in the interest rate for the life of the loan, if interest rates significantly drop in the market, you would have to refinance to take advantage of the better rates – and refinancing costs money.

Pros Cons Ideal Loan For
Stability of payment amounts, able to accurately budget for the future. Not able to change the interest rate easily if the market rate lowers, higher interest rate than Adjustable-rate mortgage. Buyers who plan on staying in their home for a long period of time, and will benefit from the stability of the same monthly payments over the life of the loan.

 

Adjustable-Rate Mortgages (ARMs)

ARMs are the riskier of the two mortgages, but greater risk can mean greater reward. An ARM comes with an initial rate period and then changes according to market trends. Interest rates for ARMs are often lower during the initial rate period compared to fixed mortgages, but after that initial period ends, rates can rise (or lower) according to market trends. The numbers at the beginning of these ARMs can tell you what the rate period and adjustment frequency will be. For example, if you see a 5/1 ARM, it means that the initial interest rate will stay the same for 5 years and then rise or lower based on the market. It will then re-adjust every year for the remainder of the loan.

Pros Cons Ideal Loan For
The rate is initially lower compared to fixed-rate mortgage, more cash at your disposal each month; rate could become lower at end of rate period. The interest rate could rise dramatically at end of the rate period (make sure to check what the maximum interest rate allowed on the loan is and decide if you could handle that worst-case scenario), no guarantee of what future payments will be. Buyers who don’t plan on staying in their home longer than the initial rate period, investors who want lower monthly payments so that they can put more money towards investments in the actual home.

Before you decide which type of mortgage best fits your needs, make sure you ask yourself these questions:

  • How long do you plan on living in this home?
  • What’s more important to you – a lower interest rate or a lower monthly payment?
  • Could you handle an interest rate that increased every few years?

If you’re still unsure, or have more questions about the difference between an adjustable-rate and fixed-rate mortgage, our experienced Mortgage Specialists can help. Contact us today and we’ll help you navigate the home-buying process.

[qd_inline_ad ad_id=”3316″]