Just like houses, mortgages aren’t one-size-fits-all. From buying discount points at closing to selecting your loan term and mortgage type, there are lots of choices to make.
The good news is you’re in full control of the decisions, and there are plenty of resources along the way to help you make the best choices for you and your situation. It’s important to be well informed before you make an important decision like taking out a mortgage. After all, it’s a huge long-term financial commitment, and you want to do it right.
We’re here to help with that. In this article, we’ll explain what you should know before making your final decision on a fixed-rate vs. adjustable-rate mortgage.
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Adjustable-Rate Mortgage Pros
An adjustable-rate mortgage (ARM) means your interest rate and payment amount will fluctuate based on market conditions, namely the index and margin.
The margin is the number of percentage points added by your lender to the index to determine your mortgage rate. The margin is based on your creditworthiness, while the index is based on economic factors outside your control. For example, if you have a strong credit history, your margin is likely to be lower than that of someone with a poor credit history.
Since economic conditions vary greatly from year to year, your index rate will adjust periodically over the life of your loan. The adjustment period refers to the frequency at which the rate adjusts. The adjustment period will depend on your lender and ARM loan type. For instance, the interest rate could change monthly, quarterly, annually, or once every three or five years.
ARMs also come with what’s known as a fixed-rate period, one of the main advantages of this particular mortgage type. Think of the fixed-rate period as a sort of introductory period. Sometimes credit card companies offer promotional periods in which you can borrow at a 0 percent interest rate. Likewise, ARMs have fixed-rate periods during which the interest rate is lower than average. The fixed-rate period could last anywhere from 6 months to 10 years.
You’re probably starting to get a sense of why certain borrowers prefer ARMs. If you’re planning to sell your home within a few years or anticipate paying off your mortgage quickly, you may want to take advantage of the lower rates ARMs offer initially.
After that initial period ends, though, your interest rate will shift with market conditions. When the economy is good, your interest rate will trend downward. When the market is more volatile, your interest rate will trend upward. However, ARMs typically come with interest rate caps, so you’ll never have to pay more than the capped interest rate amount.
Adjustable-Rate Mortgage Cons
On the other hand, ARMs may not be the right fit for certain financial situations. For instance, if you have a tight budget, or simply aren’t great at managing the family budget, a fluctuating monthly mortgage payment may be difficult to handle.
Likewise, if your ARM comes with an interest rate cap, you run the risk of having a sizable mortgage payment. Unexpected circumstances, such as the pandemic, which shut down many businesses, can put a wrench in people’s finances and make ARMs a riskier loan type. If you’re leaning toward closing on an ARM, make sure you’re prepared for the worst-case scenario so you’re never stretched too thin.
Fixed-Rate Mortgage Pros
Fixed-rate mortgages come with … you guessed it … a fixed interest rate. With a fixed-rate mortgage, your interest rate will remain the same over the life of the loan. You’ll have a fixed monthly mortgage payment, meaning there’s little guesswork when it comes to how much you’ll owe on your home each month. Fixed-rate mortgages can make balancing the monthly budget much easier.
Closing on your home in a strong economy when interest rates are low? Planning on remaining in your home for the foreseeable future? You can take advantage of market conditions by getting a competitive interest rate that will remain locked for the duration of your loan term.
While ARMs offer flexibility, many homeowners find security in the predictability of fixed-rate mortgages.
Fixed-Rate Mortgage Cons
But what if interest rates have been trending upward in the months leading up to your home purchase? You may be wondering whether it’s beneficial to close on a fixed-rate mortgage when market conditions are more uncertain.
There’s certainly a downside to closing on a fixed-rate mortgage only to watch interest rates decline in the months following your closing. You may feel stuck and frustrated that you’re locked into a higher interest rate when you could have saved hundreds, perhaps thousands of dollars, by closing at a more optimal time.
We understand that circumstances are fluid. Market conditions and your own personal financial situation will likely change over time. So keep in mind that refinancing is always an option if your current home loan no longer suits your present needs. Whether you start with a fixed-rate mortgage or an adjustable-rate mortgage, you remain in control of the decisions you make about your home loan.
No one is able to predict the future. The best thing you can do is weigh the pros and cons of each mortgage type and consider them in light of your current financial situation and goals. There’s no right or wrong mortgage type. There’s only the mortgage type that’s right for you.
If you live or work in Washington State and you want to learn more about fixed-rate vs. adjustable-rate mortgages or homeownership in general, contact Solarity Credit Union. They’ll empower you with the knowledge you need to make the right financial decisions for you and your family.
