Choose The Better Mortgage Option For Yourself: Fixed Or Adjustable
In the loan process one of the most crucial decisions, and usually the most difficult as well, is whether to opt for a fixed rate mortgage or adjustable rate mortgage.
Adjustable-rate mortgages (ARMs) prove to be highly tempting for homebuyers but they come with a high degree of uncertainty. Rates may rise again, which is the reason why over 75% of homeowners choose a fixed-rate mortgage. Interest Rates Can Be Decisive In fixed mortgage rate, a firm interest rate is offered for a predetermined loan amount. The rate remains constant throughout the life of the loan and so does the monthly payments until the loan has been repaid. For a fixed loan the rate charged is typically higher than that of adjustable mortgage rate. Fixed mortgages are generally for large purchases. In the case of adjustable rate mortgage, it may change over time due to the interest rate going either up or down. ARMs are bound to several indexes, usually published interest rates. The amount added by a lender to the index is the margin, usually two or four percentage points, to set the actual interest of the adjustable rate mortgages. Rate charges mostly peak at 2 percentage points annually and a maximum of 6% over the duration of the loan. 30-Year or 15-Year Fixed Rate Mortgages Lenders mostly offer various options for mortgages with the most common being the fixed-rate mortgage for 30 or 15 years. 30 year fixed rate mortgage is an industry standard, as total payments are spread over many years to make your monthly payments lower than in the case of a shorter-term loan. The interest rate is set or locked in at the time of getting the mortgage stays constants through the life of the loan. A 30 year loan can cost thousands of dollars more in interest than a shorter term debt but since the interest is 100% tax deductible, after tax cost is significantly reduced. However 15 year fixed rate mortgage is increasingly becoming common, as borrowers pay a lower interest rate in return for larger monthly payments. A 15 year fixed rate mortgage gives you an interest rate typically 25%-50 % lower than a 30 year fixed rate mortgage. The shorter the term, the lower the interest. But the main advantage is in the huge interest savings you make during the life of the loan.
Is ARM For You? The initial ARM rate tends to be lower than the fixed mortgage rate even if the current economy has only slightly lowered the one-year ARM rate to one-quarter or one-third of a percentage point. Following the initial fixed period, ARMs mostly adjust on each anniversary of the mortgage. Some ARMs adjust every three years based on yields on three-year treasury securities. The new rate is actually set about 45 days before the anniversary, based on the index at the time. If your plan to be in the house is less than five years, it's better to take the lower rate ARMs, particularly if rate adjustments happen only every three years. However, if planning for many years, ARMs may be a huge risk. Take an example of a family able to finance a $200,000 mortgage over 30 years at 6% fixed rate. The monthly mortgage payment is $1,200. The same mortgage financed with an ARM at 4.5% is $1,013. Thus the saving for the family can be $187 per month or around 15%, with the ARM. While the 15% savings seem good, it may not be if rates rise. If rates rise to 8%, the fixed rate mortgage doesn't but the adjustable rate mortgage shoots to $1,467 per month, an increase of $454 or about 45% per month.
Conclusion In today's market a fixed rate mortgage may cost more but the higher interest rate can be worth the cost. Like a kind of insurance, a fixed rate mortgage ensures that despite interest rates rising, the monthly house payment remains constant, while ARMs may be better for short-term needs for the loan. However when financing a home or planning several years' stay, ARMs may prove a big risk.
