Fixed-Rate or Adjustable-Rate Mortgage
When shopping for a home loan, the first step is determining which loan type best suits your needs: a fixed-rate or adjustable-rate mortgage.
Fixed-Rate Mortgage
A fixed-rate mortgage remains unchanged throughout the life of the loan by charging a set interest rate. The payments will be the same each month which makes budgeting easier. A buyer can choose either a 15-year term or a 30-year term. The term is the time it will take to pay off the loan. A shorter-term mortgage will have a lower interest rate at a higher monthly payment. The payment is higher because the borrower must repay the principal amount of the loan in less time. The main advantage of a fixed-rate loan is that the borrower is protected if interest rates rise over the life of the loan. The downside is that when interest rates are high, the payments are less affordable, making it more challenging to qualify for a loan. Another downside is that borrowers are locked into their interest rate if interest rates drop. The homeowner will have to refinance their existing loan to take advantage of lower interest rates, which can be a cumbersome process.
Adjustable-Rate Mortgage (ARM)
An adjustable-rate mortgage will change over the life of the loan based on market interest rates. Initial interest on an adjustable-rate mortgage (ARM) is set below the market rate for a fixed time. The fixed period could be anywhere from one month to seven years. Once the fixed period ends, the loan will reset to a new interest rate based on current market rates. When the loan resets, the homeowner’s monthly payments could increase or decrease, and they will be locked in until the next reset.
Low initial payments could enable the borrower to qualify for a larger loan. If market rates drop, the borrower will have lower monthly payments due to lower interest. However, if market rates go up, so does the monthly payment. An adjustable-rate mortgage may be a good choice if you know you’re going to move within a short period and won’t live in the home long enough for the term to change.
Adjustable-rate mortgages are not as straightforward as fixed-rate mortgages. Before jumping in, ask the following questions:
- How soon will the payment change?
- How frequently will the interest rate adjust?
- Is there a cap on how high the interest rate could go?
- Is there a limit on how low the interest rate could go?
- What direction are interest rates heading today, and will that trend continue?
When choosing a mortgage, you need to consider the economic realities of an ever-changing market. If interest rates are high and expected to fall, an adjustable mortgage will take advantage of the drop. However, if interest rates are low, run the numbers to determine the worst-case scenario. If a predictable monthly payment is important to you, a fixed-rate mortgage may be the way to go. If you are not sure which mortgage is right for you, your mortgage broker will be able to help.
If you would like some more information about buying a home, or if you’re looking for a great REALTOR® to show you around the Reno-Sparks area, contact the David Morris Group. We’re happy to be your helpful guide. Give us a call at (775) 828-3292.
