A Guide to Understanding Adjustable and Fixed Rate Mortgages
When it comes to buying a home, many individuals and families opt to take out a mortgage for financing. However, choosing which type of mortgage to obtain can be a daunting decision. Two common options are adjustable-rate mortgages (ARMs) and fixed-rate mortgages (FRMs). As their names suggest, ARMs and FRMs differ in terms of interest rates and payment plans. In this blog post, we will provide a comprehensive guide to help you understand the differences between adjustable vs fixed rate mortgages , so that you can make an informed decision when it comes to financing your dream home.
A fixed-rate mortgage is a type of mortgage where the interest rate remains the same for the entire term of the loan. This means that the monthly mortgage payments and the interest rate will remain constant over time. FRMs are the most common type of mortgage and are popular among those who prefer a sense of stability and predictability with their finances. The terms for fixed-rate mortgages are typically 15 to 30 years, and the interest rates can be higher or lower based on the market conditions.
An adjustable-rate mortgage is a type of mortgage where the interest rate is based on a benchmark index and can change over time. The rate typically changes annually, but could also change quarterly or semi-annually depending on the terms of the mortgage. Because the interest rate on an ARM can change over time, the monthly mortgage payment can fluctuate as well. ARMs can have a lower initial interest rate compared to FRMs, making them attractive to people who want to take advantage of favorable market conditions.
ARMs typically have a lower introductory interest rate referred to as a “teaser” rate. This lower rate is usually in effect for the first one to ten years of the mortgage term. After this period, the mortgage rate is subject to adjustment based on the benchmark index. The benchmark index is usually tied to a specific financial index, like the U.S. Treasury bill rate or the LIBOR rate. When the benchmark index increases, so does the interest rate on the mortgage, increasing the monthly mortgage payment as well.
Fixed-rate mortgages provide a sense of stability because the interest rate and monthly payment remain the same for the entire term of the loan. This makes it easier to budget and plan accordingly. On the other hand, adjustable-rate mortgages can have lower initial interest rates, and can be a better option if you plan to sell the property after the initial rate period ends. Additionally, if you believe interest rates will decrease in the future, then an ARM may be a good option for you.
When choosing between an ARM and an FRM, it’s essential to consider your overall financial goals and situation. If you plan to keep your home for a long time, then an FRM would be a better option because it provides financial stability and predictability over the long term. On the other hand, if you plan to sell your home after some time, then an ARM may be more suitable as it can offer lower initial interest rates, allowing you to pay less monthly for the first few years.
In conclusion, deciding between an adjustable-rate mortgage and a fixed-rate mortgage is an important decision when it comes to purchasing a home. While each type of mortgage has its advantages and disadvantages, knowing the difference between the two can help you make an informed decision that is rooted in your overall financial goals and current financial situation.
By understanding how each type of mortgage works, you can select the plan that is right for you and plan for your home purchase accordingly. Take the time to compare the pros and cons of fixed-rate mortgages and adjustable-rate mortgages and make an informed decision. Good luck!