A Bamboozling Dilemma: Fixed Rate or Adjustable Rate Mortgage?
BY Matt Peters
A lot of people who plan to buy a house often wonder what kind of mortgage is right for them: an adjustable rate mortgage or a fixed rate mortgage. To be able to determine the suitability of a mortgage type, potential buyers should familiarize themselves with the advantages and disadvantages. This way, they enable themselves to come up with informed decisions.
Depending on the term of the mortgage and a borrower's financial needs, both the adjustable rate mortgage and the fixed rate mortgage are appealing to various types of homebuyers. But it is essential that homebuyers become aware of the difference between the two kinds of mortgages.
An adjustable rate mortgage, or an ARM for short, is commonly known as a variable rate mortgage. This mortgage features an interest rate linked to an economic index. Interest rates and mortgage payments are occasionally adjusted in keeping with the changes in the said index. The primary interest rate for an adjustable rate mortgage is lower compared to the rate of a fixed rate mortgage, which features an interest rate that remains unchanged for the entire life of the loan. In contrast to the fixed rate mortgage, the adjustable rate mortgage offer borrowers the choice to make an early repayment of the initial principal borrowed without a penalty charge.
A principal reason why you should consider an adjustable rate mortgage is that you may end up with a lower monthly mortgage payment. Because you're taking a risk with unpredictable interest rates, you are rewarded with an initial rate that's lower compared to an adjustable rate mortgage. You can consider an adjustable rate mortgage a good option if: you plan to stay in your home for only a few years; you anticipate an increase in your future income; or, the existing interest rate for a fixed rate mortgage is too high.
One disadvantage of the adjustable rate mortgage is that there is a risk that the rates will rise on you, which means that your monthly mortgage payment will increase significantly. It is possible that the payment can get too high that you may have to default on your loan.
On the other hand, a fixed rate mortgage features an interest rate that is fixed for the entire life of the loan, even if the mortgage lender's interest rate rises and falls in the future. Because the payments are predetermined, homeowners can budget the amount they need to set aside for their monthly mortgage payment. They can also afford to plan their finances for the long-term.
The drawback is that this type of mortgage comes with higher interest rates. Also, with a fixed rate mortgage, lenders often set up a prepayment penalty that dissuades borrowers from paying off their mortgage early or refinancing their mortgage loan with a lower interest rate. This type of mortgage also puts borrowers at a disadvantage when interest rates fall. However, borrowers can shift to a mortgage program that enables them to benefit from lower interest rates. One way to do this is to qualify and pay for mortgage refinancing.
Compared to an adjustable rate mortgage, the fixed rate mortgage is a more attractive choice for borrowers who opt for a long-term plan. The fixed rate mortgage also offers more security for buyers and is best suited for homeowners who wish to keep their houses for a longer period of time.
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