When shopping for a home or investment property, buyers must decide which type of loan will best fit their needs. An adjustable-rate mortgage and a fixed-rate mortgage are the two most popular types of home loans.
Even before a potential buyer finds the perfect home or investment property, reviewing the different loan options is a good idea. Understanding the key differences between an adjustable rate and a fixed-rate mortgage will help simplify the evaluation process. Discussing your loan options with a local lender is also a good idea as they can answer any additional questions you may have and help you determine how much home you can afford before you start shopping. Getting pre-qualified in advance can make your offer more powerful to sellers.
What are Adjustable-Rate Mortgage Loans?
Often called an “ARM,” these home loans typically offer qualified borrowers low-interest rates during the introductory period (typically five or seven years.) After this intro period ends, the interest rate is calculated monthly or yearly against a standardized index.
For example, a 5/1 ARM has a five-year fixed mortgage rate period. Following the five-year introductory period, the annual interest rate is recalculated once each year based on a predetermined index. People who select an adjustable-rate mortgage enjoy a low-interest rate for the introductory period. If interest rates begin to increase after the introductory period, homeowners have the option to refinance to a fixed mortgage.
What are Fixed Rate Mortgage Loans?
These mortgages offer qualified borrowers an interest rate that remains the same throughout repayment, and the monthly principal and interest payments will not fluctuate. Typically, borrowers have the option to lock in a rate for a 10, 15, or 30-year term.
Adjustable-Rate Mortgage Pros and Cons
At first glance, the difference between these mortgage loans may appear to be the fluctuating versus fixed interest rate. While that certainly is a key difference, there are long-term effects of these differences. If you are mortgage shopping, consider the following.
Adjustable-Rate Mortgage Pros
- Low Monthly Payments During Fixed Rate Period
- Caps Placed on Adjustable-Rate Increases
- Payments Could Decrease
Adjustable-Rate Mortgage Cons
- Monthly Payments Could Increase
- Could Pay More Over Life of the Loan
- Difficult to Plan Monthly Finances after the Intro Period
Fixed Rate Mortgage Pros and Cons
It’s important to understand that one type of home loan is not necessarily better than another. The goal is to select the option that best serves your interests and financial goals. Weighing the pros and cons of a fixed-rate mortgage is important before you decide on which loan option is best.
Fixed Rate Mortgage Pros
- Easy to Plan Monthly Expenses
- No Risk of Interest Rate Increase
- Early Repayment Flexibility
Fixed Rate Mortgage Cons
- Cannot Take Advantage of Declining Rates
- Could Pay More Over Life of the Mortgage
- No Low-Rate Introductory Period
Is an Adjustable Rate or Fixed Rate Mortgage for You?
These types of home loans are sometimes used for different reasons. In other words, buyers may consider the potential savings over the life of the loan as just one factor among many.
A fixed-rate mortgage may make perfect sense for homeowners who intend to put down roots, raise a family, or pursue career goals in an area. A fixed-rate loan may also fit into a long-term business plan that involves buying and operating an investment property.
An adjustable-rate mortgage is more favorable if relocation is part of the homeowner's plan. If someone knows that they will need to move for work, military service, or other reasons, an adjustable-rate mortgage typically offers a lower monthly installment. In such cases, borrowers benefit from the introductory period with little concern about the adjustable phase coming to an end.
Another scenario that makes an adjustable-rate mortgage a great option is the financing of short-term business goals. Developers and house flippers who buy and rehabilitate properties can take advantage of low-interest introductory periods. By selling a real estate investment relatively quickly, investors can turn higher profits with at a lower rate.
How to Find the Right Mortgage Lender
Applying for an Adjustable-Rate Mortgage or Fixed Rate Mortgage can be relatively straightforward. Consider checking your credit score by reviewing a free copy of your credit report. Clear up any errors or inconsistencies by reporting them to Equifax, Experian, or TransUnion.
If you are still unsure which mortgage is best for your financial situation, contact Middlesex Federal Savings to speak with a trusted home loan specialist today.