Fixed rate vs. adjustable-rate mortgages (ARMs). Like most things in the financial realm, there is no singular answer to what might fit every homeowner’s needs, every time. Instead, there are certain instances where a fixed-rate mortgage makes great financial sense. In others, an ARM is the most cost-effective choice. Here’s a quick break down of fixed- and adjustable-rate mortgages, and who can – and should – take advantage of either.
A fixed-rate mortgage is a home loan with, not surprisingly, a fixed interest rate. The cost of loan via the interest rate is set during your application process. It does not change for as long as the loan remains in repayment. Fixed interest rates are based on broad market conditions and several other factors unique to the buyer. These include credit score, down payment amount, the location of the home, and the type of mortgage program used. The combination of these factors may cause one home buyer to have a different interest rate offered than their neighbor, despite what prevailing market interest rates may be.
But one thing remains constant – all fixed-rate mortgages maintain the same interest rate from start to finish.
On the contrary, adjustable-rate mortgages offer a fixed interest rate for only a set period. After that time, the interest rate adjusts based on broad market conditions. ARMs list the fixed-rate period first, followed by the term or frequency of the adjustment period. So, a 7/1 ARM offers an initial fixed interest rate for the first seven years of the loan and then adjusts each year after that. The rate offered to a homebuyer at the time an application is submitted is also based on certain factors, like credit history and home price. However, the rate adjustments are solely determined by changes in the interest rate market at large.
ARM interest rates can go up or down based on movements in the market. That is the main reason having an adjustable-rate mortgage when rates are on the rise can be a concern.
Adjustable-rate mortgages have been a go-to for first-time homebuyers for many years. Typically, the interest rate for the initial fixed term is often (but not always) lower than a conventional fixed mortgage rate. This provides greater affordability to purchase more house for the money each month. Similarly, ARMs are a smart choice for any home buyers who plan to stay in their home for a short period. Ideally, fewer years than the initial fixed-rate period. When this scenario is in play, homeowners can sell their home before the rate adjusts, and purchase their next home with a new ARM with a new fixed period. They could also use a fixed-rate mortgage for their next home endeavor.
Fixed rate mortgages work best for homebuyers who want predictability in their monthly payments. It’s easy to budget when the mortgage is the same amount for the life of the loan. A steady income and stable job conditions lend themselves to fixed-rate mortgages. However, there are additional scenarios where opting for this mortgage type is a better choice. Current homeowners who have an adjustable-rate mortgage that is on the verge of resetting up can take advantage of refinancing into a fixed-rate mortgage, saving them from a jump in the monthly payment.
Similarly, homeowners who have stayed in their home longer than anticipated (i.e., longer than the initial fixed rate period of an ARM) may benefit by refinancing out of an ARM into a fixed-rate mortgage. This gives the option to avoid an interest rate increase in the near future.
The great news is that nearly everyone has varied options for the type of mortgage they can and should use to finance the transaction. But, it requires understanding the differences between a fixed-rate and adjustable-rate mortgage. That goes for a first-time homebuyer, a seasoned pro, or a current homeowner looking for refinancing solutions.
If you’re in the tl;dr (too long, didn’t read) camp, the comparison chart below gives you most of the pertinent details you need to make an informed decision. Still have questions? Reach out to our experts at SnapFi to determine what’s best for your home buying and ownership needs