Fixed Rate Loans Vs. Adjustable Rate Loans
Adjustable rate mortgages continue to be one of the more controversial topics among homebuyers. I’m asked about them practically every day in fact. I can understand why, as adjustable rate mortgages do carry some strong advantages over fixed-rate mortgages.
Instead of turning this into a long commentary, I figured you’d benefit more from a good old fashioned pros and cons list. Sound good? Quick, simple, and to the point! Let’s start off with adjustable rate loans first:
- Feature lower rates and payments early on in the loan term. Lenders often use the lower payment when qualifying borrowers, so you can qualify for a larger home.
- You can enjoy falling rates without refinancing if rates drop. Instead of going through the hassle (And expense) of a refinance to benefit from a lower rate, your adjustable rate will drop all on its own – You just kick back and enjoy the lower payment!
- Save and invest the money you save. Let’s say that your payment is $100 a month lower with an adjustable rate vs. A Why not put that extra cash into a high-yield interest bearing account?
- Enjoy lower payments if you plan on living somewhere temporarily. (2 – 3 years)
- Rates and payments can rise after the initial lock period has expired. (2 – 7 years) A 4 percent ARM, for example, could end up at 9 percent in just three years if rates were to rise rapidly.
- The first adjustment can result in sticker-shock if your loan comes with high caps. (A cap is a limit to how much your rate can rise on a per year basis)
- ARMs can be confusing and difficult to compare if the lender is not being transparent. An ARM can be structured in so many ways, it can be difficult to compare one with another.
- No concern over rate changes. As the name implies your rate is fixed the entire length of the loan.
- Certainty in payments makes budgeting decisions easier as there is no concern over future payment fluctuation.
- Easy to compare/shop. A plain vanilla loan program that allows you to compare overall costs across the board.
- If rates drop, you cannot take advantage of the lower payments without the hassle and cost of a refinance.
- May not qualify for as much home as you would with a lower payment ARM
- Plain vanilla… Meaning that a 30 year fixed rate mortgage is pretty much the same across the board. This means you don’t have the same flexibility of an ARM to be customized to your personal situation.
Hopefully the above gives you some things to think about. Here are some other important questions to consider before making your decision:
- How long will you stay in the home?
If you’re going to be living in the house for just a few years, the lower-rate of the ARM makes more sense. I’d recommend looking into a 3/1 or 5/1 ARM.
- How frequently would the ARM adjust?
After the initial, fixed period, most ARMs adjust every year on the anniversary of the mortgage. But some ARMs adjust every month. This might be too much volatility for some, in which case a fixed rate would be more appropriate.
- What are interest rates doing?
When rates are higher, ARMs make more sense because the lower initial rates help borrowers to qualify for more home due to the lower payments. Then, when rates begin to fall, borrowers have a stand a good chance of tapping into those lower payments even if they don’t refinance. When rates are low, however, a fixed-rate mortgage often makes more sense.