There are many types of mortgage programs available. The right type of loan for you depends upon several factors:
- Your current financial situation
- How you expect your finances to change
- How long you intend to keep your home
- How comfortable you are with the possibility that your mortgage payment may rise in the future
When considering loan programs, the first decision is usually whether you prefer a fixed-rate
mortgage or an adjustable–rate mortgage (commonly referred to as an ARM). For example, a 5–year ARM will have a lower initial payment than a 30–year fixed–rate mortgage, but the interest rate and payments can increase over time.
Fixed Rate Mortgage vs. Adjustable Rate Mortgage
Fixed Rate Mortgage
A Fixed Rate Mortgage applies the same interest rate toward monthly loan payments for the life of the loan. Fixed–rate mortgages are more straightforward and easier to understand than Adjustable Rate Mortgages (ARMs), are more secure for the buyer, and are popular with first–time homebuyers. Since the risk to the lender is higher, fixed–rate mortgages generally have higher interest rates than ARMs.
For example, a lender can offer a 30–year fixed loan to a homebuyer at a 7.0% interest rate. The loan is locked in to the 7.0% interest rate, even if the market interest rate rises to 9.0%. Conversely, if the market interest rate decreases to 5.5%, the borrower will continue to pay the 7% interest rate.
Fixed Rate Mortgage benefits include:
- No change in monthly principal and interest payments regardless of fluctuations in interest rates
- More stability may give you "peace–of–mind"
Fixed Rate Mortgage considerations include:
- Higher initial monthly payments compared to those of adjustable rate mortgages
- Less flexibility
Adjustable Rate Mortgage
An Adjustable Rate Mortgage (ARM) does not apply the same interest rate toward monthly payments for the life of the loan. Throughout the life of that loan, the homebuyer's principal and interest payment will adjust periodically based on fluctuations in the interest rate.
For example, a lender could offer a 30–year ARM loan to a homebuyer at an initial 6.5% interest rate. During an adjustment period for the ARM loan, the market interest rate could rise to 8.0%, resulting in a significantly larger interest payment. Similarly, the market interest rate could decrease to 6.0%, resulting in lower interest payments.
Adjustable Rate Mortgage benefits include:
- Initial payments lower due to lower beginning interest rate, usually about 2 percentage points below the fixed rate
- Ability to qualify for a higher loan amount due to lower initial interest rates
- Lower interest payments if the interest rate drops over time
- Interest rate caps limit the maximum interest payment allowed for the loan
Adjustable Rate Mortgage considerations include:
- Initial lower interest rate and monthly payments are temporary and apply to the first adjustment period. Typically, the interest rate will rise after the initial adjustment period.
Higher interest payments if the interest rate rises over time
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