FHA Fixed Rate
Fixed Rate vs. Adjustable Rate Mortgages: Which Is Better?
With mortgage loans, you will typically encounter two basic types: fixed rate mortgages and adjustable rate mortgages (ARM's).
Every homebuyer will have to decide which one of these types is best for their situation, based on a number of factors. The following information will educate you on the differences between the two and allow you to make an informed decision between fixed-rate and adjustable-rate mortgages.
Fixed-rate loans feature interest rates that remain the same for the life of the loan. They are fixed and unchanging.
Naturally, these loans provide predictability. You never have to guess what your payment is going to be from month to month, which comes in handy when you’re trying to work out your monthly budget. Bills for healthcare and car or home repairs may fluctuate dramatically every month, but at least you know what your house payment will be.
On the flip side of that, interest rates on fixed-rate mortgages are permanent. If you got your loan at a high interest rate, it’s going to stay that way for a long time. The only way to change that is to go through a refinance, including paying for loan origination fees and closing costs, to get a lower rate.
Adjustable Rate Mortgage
ARM loans are the opposite of fixed-rate loans—their interest rates go up and down with the market. Typically, these loans start you off at a lower interest rate, keeping your monthly payments low, which income-strapped borrowers appreciate. This also gives borrowers an attractive debt-to-income (DTI) ratio, so they can qualify for a bigger loan. These loans are great while interest rates remain low, if you plan to stay in your home for short period of time, or if you don’t have a lot of cash to put down at first. But once interest rates start going up, monthly payments can quickly grow larger than the borrower can afford.
During the recent housing crisis, this particular type of home loan caused major issues for many homeowners. These borrowers were fine while interest rates were low, expecting to make quick money on flipping their property after just a couple years. But when the market collapsed, property values plummeted, ARM payments started rising, and these homeowners were forced to default.
The Elements of an ARM
ARM loans can be more dangerous than fixed-rate loans because they tend to be so much harder to understand. However, by knowing the jargon attached to ARMs, you are much more likely to make an educated decision:
- Index - There is any number of these that a loan can be tied to, including the 1-Year London Interbank Offered Rate (LIBOR) or the Constant Maturity Treasury Index (CMT).
- Margin - Loan rates mirror the index rate and then add a specific percentage above it, the amount which is called the margin. For instance, if the index rate is 2% and the margin is 2%, the loan rate will be 4%.
- Initial Interest Rate Period - This refers to the time at the start of a loan when the interest rate is fixed. After this period, the interest rates begins to follow the fluctuations of the market rate. Anyone who gets an ARM loan should know what this period is and act before this period is over to avoid an increase in their interest rates.
- Adjustment Frequency - This spells out how often the interest rate will adjust—monthly, yearly, or by some other measure.
- Rate Cap Structure - To protect the borrower if rates rise, ARM loans put caps—annual or lifetime limits—in place on the amount the interest rate can change within a given time period. Annual limits dictate that the loan can change only by a specific amount each year. Lifetime limits prevent drastic changes in the interest rate over the long term. If you must get an ARM loan, both features are recommended.
Which is best for you: a fixed-rate or an adjustable rate mortgage? To learn more, contact a Mortgage Advisor today.