If you are looking to buy a home, refinance your current home, or purchase an investment property, you are likely in the market for a mortgage loan. You probably know that a mortgage is a loan you can use to finance your home purchase. You may not know the difference between the two most common types of mortgage products: Fixed-Rate Mortgages and Adjustable-Rate Mortgages (ARMs).
The core difference between these two mortgage products is the interest rate. With a Fixed-Rate Mortgage, the interest rate is set at the time of purchase and remains the same over the life of the loan. With an Adjustable-Rate Mortgage, the interest rate varies and changes with market conditions.
There are pros and cons to each of these types of mortgage loans. Which one is better? Well, that depends on your individual circumstances. Read on to learn more about the differences between Fixed-Rate and Adjustable-Rate Mortgages so you can choose the right mortgage for you.
Fixed-Rate Mortgage
The most common type of mortgage is the Fixed-Rate Mortgage. With Fixed-Rate Mortgages, the interest rate never changes. The interest rate is set at the time of purchase and remains the same over the life of the loan.
The most significant advantage of a Fixed-Rate Mortgage is that you always know how much your mortgage payment will be. Whether you hold the mortgage for 5 years or 30 years, you pay the same amount every month. Your interest rate will never increase. For most people, a predictable mortgage payment is a key to achieving financial stability. Fixed-Rate Mortgage holders have peace of mind that they can afford their mortgage.
The biggest disadvantage of a Fixed-Rate Mortgage is that you cannot take advantage of those lower rates if interest rates go down. Because your rate is locked, you need to refinance your mortgage to get a lower rate. This is especially significant for people who purchase a mortgage when interest rates are high. A lower interest rate will lower your monthly payment and could save thousands of dollars in the long run.
Consider this example:
If you have a mortgage loan of $250,000 at a fixed rate of 3.5% with a 30-year term, your monthly mortgage payment is $1,123, and your total cost over the life of the loan is $404,140, with $154,140 paid in interest.
Now let’s say you have the same 30-year, $250,000 mortgage loan at a fixed rate of 7%, your monthly mortgage payment is $1,663, and your total cost over the life of the loan is $598,772, with $348,772 paid in interest.
That’s a difference of $540 per month and $194,632 in interest over the life of the loan. In an example like this one, it’s easy to see how a seemingly small difference in your interest rate can greatly affect your ability to afford your mortgage.
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Many people assume they can always refinance, but this is a risky assumption. If your income or credit score changes, or if the value of your property decreases, you may be denied approval to refinance. You must also keep in mind that it will probably cost several thousand dollars in closing costs and taxes to refinance your loan. This cost must be considered when deciding whether refinancing is the right move.
Adjustable-Rate Mortgage (ARM)
For some people, an Adjustable-Rate Mortgage is a great option. With this type of mortgage loan, the interest rate fluctuates according to market conditions. It may go up or down depending on how the economy is performing.
Most ARMS have a defined schedule at which the rate will change, known as the adjustment period. Commonly, your rate may be adjusted annually. Some ARMs have a minimum interest rate and maximum interest rate, which may help to mitigate the risk involved.
ARMs can be complicated. Be sure to read your paperwork carefully and understand your agreement before you sign.
The most significant advantage of an Adjustable-Rate Mortgage is that it may offer the lowest initial rate. This rate is known as the “teaser” rate because it is only valid for the first adjustment period. A lower initial rate will lower your payment and may help you qualify for a larger loan. For people who will hold the mortgage for a short time (like investors or house flippers), a low initial rate can amount to huge savings.
The biggest disadvantage of an Adjustable-Rate Mortgage is the risk that interest rates rise and increase your monthly payment. An unpredictable mortgage payment makes it difficult to budget properly and may lead to financial troubles for many people. Nobody wants to be in a position where they suddenly cannot afford their mortgage.
A Fixed-Rate Mortgage may be right for you if:
- You want a predictable mortgage payment.
- You plan to hold the mortgage for more than a few years.
- You are purchasing the property when interest rates are low.
An Adjustable-Rate Mortgage may be right for you if:
- You are risk-tolerant and think the financial benefit is worth it.
- You plan to hold the mortgage for less than a few years.
- You need the lowest possible rate so you can qualify for a larger loan.
If you need help to decide which mortgage purchase or refinance loan is best for you, Cape Coral Mortgage can help. Call us today! Our knowledgeable loan officers are here to help you make the right choice for you.
