Fixed or Adjustable Interest Rate Mortgages. Which is right for you?
The differences between a Fixed Interest Rate Mortgage and an Adjustable Interest Rate Mortgage are really quite simple. Determining which product is the right fit for you may be a little more difficult, but once you understand the basics of both home loan options, you should be able to make the right choice for your income and lifestyle. Fixed vs. Adjustable - Plain and Simple...
The Fixed Interest Rate Mortgage (FRM)
With a Fixed Interest Rate mortgage, the interest rate remains the same throughout the life of the home loan, whether it is 15 or 30 years. Since the payments of principal and interest remain constant, a Fixed Interest Rate mortgage provides greater stability and therefore makes it easier to budget. There won't be any surprises even if inflation surges and mortgage rates become higher.
The Adjustable Interest Rate Mortgage (ARM)
An Adjustable Rate Mortgage (ARM), allows you to lock into low mortgage rates for a short amount of time. Once that time has passed, the mortgage rate will then adjust accordingly to a schedule that has been predetermined by the structure of the home loan. For instance, a 5/1 ARM will remain fixed for five years then will adjust once a year, usually on the anniversary of the loan, for as long as you retain the mortgage. An Adjustable Interest Rate mortgage may be right for you if anticipate your stay in a home or property to be for a short period of time... say 7 years or less. An Adjustable Rate Loan will also allow you to take advantage of lower mortgage rates that you thought you had missed; therefore giving you a lower monthly payment for the first three, five or seven years depending on the product you choose. Additionally, if current mortgage rates go down within those first 3, 5 or 7 years, you won't need to refinance to take advantage of the lower rates. Of course if interest rates go up, you run the risk of paying more than you might be able to afford.
What type of Interest Rate Option is Right for You?
There are several ways that you can determine the right type of mortgage for your situation. Ask yourself how long you plan to be in the property. The fixed interest rate mortgage is more stable and would probably be a better fit for someone who plans on staying in their home for a longer period of time; while the adjustable interest rate might be better suited for someone contemplating a move in a few years perhaps to a different neighborhood or a larger home.
While the aforementioned should factor into your decision between a fixed interest rate mortgage or an adjustable one, there are some additional questions you should ask yourself before you decide which home loan option is better for you:
How frequently does the ARM adjust, and when is the adjustment made?
After the initial fixed period, most ARMs adjust every year on the anniversary of the mortgage. The new interest rate is actually set about 45 days before the anniversary, based on the specified index. But some adjust as frequently as every month. If that's too much volatility for you, consider a fixed rate mortgage (FRM).
What's the current mortgage rate environment like?
When mortgage rates are higher or on the rise, ARMs may be a better option due to the lower initial rates that allow borrowers to reap the benefits of homeownership. If mortgage rates drop, borrowers with Adjustable Rate mortgages may see lower payments even if they don't refinance. However, when overall market rates are relatively low, FRMs may make more sense and provide long term stability.
Could you still afford your monthly payment if interest rates rise significantly?
On a $150,000, 5-year adjustable-rate mortgage with 2/2/6* caps, did you know your 5.75 percent ARM could end up at 11.75 percent?
Understanding CAPS ?
The first digit with the CAPS (2/2/6), is how much the interest rate can adjust at the first adjustment point. So, if you have a 5/1 ARM, with 2/2/6 CAPs, your rate may adjust up or down no more than 2% at the first adjustment date.
The second digit of the CAPS (2/2/6) is how often the interest rate will change . So, if you have a 5/1 ARM, with 2/2/6 CAPS, your rate will adjust up or down no more than once every two years.
The third digit of the CAPS (2/2/6), is your maximum lifetime interest rate adjustment cap using your start rate as base interest rate. So, if you have a 5/1 ARM start rate of 5.75% for the first five years of your mortgage with CAPS (2/2/6), your interest rate will never be higher than 11.75%.
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Learn more about Adjustable Rate Mortgages. Download here his informative fact filed Adjustable Rate Mortgages handbook.