Articles & Tips
Adjustable Rate Mortgage vs. Fixed Rate Mortgage
Most mortgages written today fall into one of two main categories: the fixed-rate mortgage and the adjustable-rate mortgage, or ARM. Knowing the differences between the two type of loans and the benefits they offer borrowers can help you determine which is the best choice for your financial needs and your monthly budget.
Adjustable-rate mortgage
These mortgages typically offer a lower initial interest rate than fixed-rate loans, but their rate will adjust over time. Most ARMs have an initial period of three or five years, during which time the initial interest remains stable. Once the initial period has elapsed, the interest rate on the adjustable-rate mortgage can adjust upward (assuming interest rates have risen), depending upon the terms set in the loan document. Because they are usually easier to qualify for than fixed-rate mortgages, an adjustable-rate mortgage is a good choice for individuals with lower credit scores or lower incomes, especially those who expect their credit or income to improve during the adjustment period, at which time they may qualify for a fixed-rate loan with a low rate. Because their lower interest rates mean a lower monthly payment, ARMs can also allow buyers to afford more substantial homes than a fixed-rate mortgage. ARMs are also a good choice for homeowners who plan to sell their homes before the loan adjusts. The primary disadvantage of ARMs is that the interest rate will adjust with time, which can mean significantly higher interest rates and higher monthly payments, as a result.
Fixed-rate mortgages
Once the tried-and-true standard for potential home buyers, fixed-rate mortgages are still one of the most popular options for home purchase and refinance, owing to their inherent stability. Unlike an ARM, where the interest rate adjusts and readjusts over time, a fixed-rate mortgage retains the same interest rate for the life of the loan. These loans are especially popular for homeowners who intend to remain in their homes for long periods of time. Most fixed-rate loans require higher credit scores and higher down payments (or more equity, in the case of a mortgage refinance) than ARMs require, making them more difficult to qualify for. Borrowers without stellar credit scores or those with down payments of less than 20 percent may find interest rates too steep for their budgets. For these reasons, many individuals move into fixed-rate loans after having an ARM for a period of several years, while they improve their credit, income, or equity.
Knowing the difference between an adjustable-rate mortgage and a fixed-rate mortgage can save you thousands when it comes time to shop for your next loan. Be sure to consider your own budget needs and select the product that will yield the greatest returns for you.
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