- September 17, 2017
- Posted by: steve
- Category: mortgage rates
Should you take on an adjustable or fixed rate mortgage? Which will benefit you in the long run? Click here to find out.
There’s a lot to wrap your head around when you’re thinking about buying a home. In addition to thinking about buying a nice home in a good neighborhood, you also have to worry about how you’re going to pay for it!
Unless you’re very wealthy, you’ll probably need to apply for a mortgage when you start planning to buy a house. Applying for a mortgage comes with its own challenges, including whether you should get a fixed rate or adjustable rate mortgage.
If you’re feeling overwhelmed already, don’t worry. We’ve put together a guide that will help you decide which type of mortgage is right for you.
What is a Fixed Rate Mortgage?
With this type of mortgage, you’re charged a, you guessed it, fixed rate of interest that doesn’t change throughout the duration of the loan.
Types of Fixed Rate Mortgage
There are two main types of fixed rate mortgages: 15-year mortgages and 30-year mortgages.
With a 30-year mortgage, you’ll often get lower monthly payments. But, the interest rate is higher and you’ll end up paying more in interest over the duration of the loan.
On the other hand, 15-year mortgages allow you to pay less interest at a lower rate. The catch is that you’ll have higher monthly payments.
What is an Adjustable Rate Mortgage?
An adjustable rate mortgage (ARM) has an interest rate that can change throughout the duration of the loan. With an ARM, your payments will usually start out lower and then increase over time.
Terms to Know
ARMs are more complicated, and there’s some terminology involved that you’ll need to understand. Some of the ARM-related terms you need to know include:
- Adjustment Frequency: The amount of time between interest rate adjustments.
- Adjustment Indexes: Adjustment indexes determine whether the interest rate will rise or fall after a certain period of time.
- Margin: When you agree to an ARM, you agree to pay a rate that is a certain percentage higher than the adjustment index. That percentage is the margin.
- Caps: The limit on the amount the interest rate can increase each adjustment period.
- Ceiling: This is the highest interest rate you can be charged for the duration of the loan.
Types of Adjustable Rate Mortgages
The following are some of the different types of adjustable rate mortgage loans you can get:
- 7/1 ARM: With this loan, you get a fixed interest rate for the first 7 years, and then it adjusts annually.
- 5/1 ARM: This loan has a fixed rate for the first 5 years, and then it adjusts annually.
- 1-year ARM: The interest rate is fixed for the first year, then it’s adjusted annually after that year is up.
Fixed Rate Advantages
These loans come with a number of advantages including the following:
Constant Rates and Payments
You don’t get any surprises with fixed rate mortgages. Even if inflation surges and mortgage rates in general skyrocket, you’ll be safe and can rely on only having to pay what you originally agreed upon.
Because you know that your mortgage rate isn’t going to change, you’ll have an easier time planning and sticking to your budget.
As you saw above, fixed rate mortgages are much simpler than adjustable rate mortgages. Because of their simplicity, they are especially good for first-time buyers who don’t want to worry about caps or margins.
Fixed Rate Disadvantages
At the same time, there are many disadvantages that come with these kinds of loans, including:
Inability to Take Advantage of Market Changes
While the consistency of a fixed rate mortgages is a positive to some people, it also makes it harder for buyers to take advantage of falling market rates. If homeowners want to do this, they have to spend a lot of extra money and time to refinance.
These mortgages can also be too expensive for a lot of borrowers, especially first-time buyers.
They also don’t take into account a borrower’s unique situation. ARMs can be customized for fit the needs of individual borrowers. But, borrowers who opt for a fixed rate will get virtually the same rate no matter which lender they work with.
Adjustable Rate Advantages
Below are some of the advantages that come with an adjustable rate mortgage.
Lower Rates and Payments Early On
When you first agree to an ARM, you’ll get lower mortgage rates and payments. These lowered payments make it easier for borrowers to get a larger home than they could afford with a fixed rate mortgage.
Freedom to Take Advantage of Falling Rates
You don’t have to worry about all of the hassles that come with refinancing if you want to take advantage of falling mortgage rates. Your payments will just decrease along with the market.
Easier to Save and Invest
With an adjustable rate mortgage, you’re able to save more money during periods when your interest rate is lowered. You can easily take that money that would have gone to your mortgage payment and invest in something that will yield you an even greater return.
Less Expensive for People Plan to Move Soon
If you have a fixed rate, 30-year mortgage, you’re probably going to do your best to stay in that house for as long as possible. This is great for people who know they want to stay in the same area for a long time. But, if you know you’re going to be moving after a few years, an adjustable rate mortgage can save you money and help you get into a house for less.
Adjustable Rate Disadvantages
Of course, an adjustable rate mortgage also has its disadvantages.
Significant Increases in Rates and Payments
Depending on market changes, you can see massive increases to your interest rates and mortgage payments when you have an ARM. It’s not uncommon for a 6 percent ARM to skyrocket all the way to 11 percent within just a few years.
First Adjustments are Dramatic
After the fixed rate period is up, the first interest rate and payment adjustment can be quite dramatic. You’ll want to keep track of when the period is complete so that you can plan for a jump in payment.
More Attention to the Economy is Required
Since your interest rate and payment is dictated by the overall housing market, borrowers with an ARM need to pay more attention to changes in the economy so that they can prepare for changes in their payments. This makes budgeting a lot harder.
More Difficult to Understand
You saw above that there’s a lot more to keep track of with an ARM. Between margins, caps, and adjustment indexes, it’s easy for first-time borrowers to get confused or trapped by less than reputable lenders.
Before You Decide
Before you make the decision about which type of mortgage to go with, ask yourself the following questions.
How Long Do I Plan to Stay in My Home?
If you only think you’ll be living in your house for a few years, an ARM will be more affordable. You’ll have lower payments and interest rates, especially if you can work it out so you have a fixed rate for those first few years. This allows you to save for a bigger home later on, and you’ll likely be out before huge rate adjustments take place.
If I’m Going with an ARM, How Frequently Will it Adjust?
Be sure to find out as much as you can about the adjustment frequency and when it will be made. Usually, the adjustment comes on the anniversary of the mortgage, but it’s still important to check so you’re not caught off guard.
Can I Handle the Volatility of an ARM?
It’s important to ask yourself if you can afford the payment changes that will come with an ARM. If you’re someone who likes consistency and being able to plan far ahead, an ARM probably isn’t for you. A fixed rate mortgage will give you peace of mind and allow you to budget more carefully.
What’s the Interest Rate Environment Like Right Now?
The state of the housing market matters a great deal when you’re deciding between an ARM and a fixed rate mortgage. When rates are high, an ARM can be a better option because you’ll get a lower rate initially. You also might be able to get lower payments later on without refinancing.
If interest rates are low, though, a fixed-rate mortgage will make more sense in the long run.
Factors that Influence Mortgage Rates
It’s also important to keep in mind the other factors that will influence your mortgage rates, whether you choose a fixed rate mortgage or an ARM. The following the most common influences on your mortgage rates:
Your credit score has a big impact on your ability to get a mortgage. This score is determined by the payment history for all of your past loans and credit cards. Generally speaking, the higher your credit score, the lower interest rate you’ll be able to get.
If you have a low credit score, you might not get approved for a loan. Or, you’ll be approved but there will also be extra conditions to protect the lender in the event that you cannot repay the debt.
It’s always a good idea to check your credit report before you apply for a loan. You can look at your report beforehand and get any errors fixed before you head to the bank. Looking at your credit report before also gives you an opportunity to fix a low credit score before applying for a mortgage.
The location of your home also influences the amount you’ll pay for your mortgage. This is why most mortgage calculators require you to include the state in which you live. Lenders also take into account whether you’re buying a home in a rural or urban area.
Home Price and Loan Amount
It’s common for borrowers to pay a higher interest rate on a home loan that is particularly large or particularly small.
It makes sense for a large loan to have a higher interest rate since there are obvious risks that come with lending a large amount of money to someone. But, why do small homes loans also come with high interest? In general, it’s because a small loan may not cover all the expenses that the bank racks up originating it.
By the time you go to a bank to apply for a mortgage, you’ll probably have already figured out the average price of a home in the area you want to move to. If you haven’t figured this out yet, do some research before you head to the bank. That way, you’ll know more specifically how much you should be asking for.
It’s common for interest rates to be lower if you pay a higher down payment on your home. This is because lenders consider borrowers to be low risk if they have paid more upfront for their home.
If you have a shorter loan term, you’ll usually have lower interest rates and lower overall costs as well. Of course, in exchange, you also have higher monthly payments. But, if you can afford the higher payments, your loan will be paid off faster, which is almost always a plus.
In addition to fixed rate and adjustable rate mortgages, there are several other broad categories of loans, including conventional, FHA, and VA loans.
Conventional loans are not insured by a government agency. On the other hand, FHA and VA loans are insured by the Federal Housing Administration and Department of Veterans Affairs, respectively.
When a loan is insured by one of these agencies, it often comes with lower interest and payment rates.
Apply for a Mortgage Today
If you’re ready to apply for a mortgage, whether it’s an ARM or a fixed rate mortgage, contact us at New Florida Mortgage today.
When you work with us, you’ll get assistance from a friendly, unbiased profession who will help you decide which option is best for you and get you into your new home as soon as possible.