If you’re planning to buy a home, you may be deciding between all of your options and weighing if a fixed rate or an ARM is a better option. When you choose a lender like us, with multiple solutions for our diverse borrowers, you may have a bit of analysis paralysis as you explore different mortgage types.
One of the big decisions borrowers make is whether to get a fixed rate mortgage or adjustable rate mortgage (ARM). Each can be the right fit depending on the market and your unique scenario, so here’s what you need to know about the pros and cons of the two.
What is a fixed rate mortgage?
A fixed rate mortgage is a type of home loan where the interest rate remains constant throughout the entire term of the loan. This means that the monthly principal and interest payments will not change over the life of the mortgage, providing predictability and stability for borrowers.
Fixed rate mortgages are typically offered in terms of 15, 20, or 30 years, with 30-year terms being the most common. It’s the most common type of loan, and probably what comes to mind when you picture a mortgage.
What is an ARM?
ARM stands for adjustable rate mortgage, but the acronym is more commonly heard in mortgage talk. In this type of loan, the interest rate can change periodically based on an index that reflects the cost to the lender of borrowing on the credit markets. Unlike fixed rate mortgages, ARMs have interest rates that can fluctuate over time, which means monthly payments can go up or down.
Pros and Cons of a Fixed Rate Mortgage
Pros
A fixed rate mortgage is straightforward and easy to understand. These are some of the benefits:
- With a fixed-rate mortgage, the interest rate remains constant throughout the life of the loan. This means your monthly principal and interest payments will not change and you can budget more effectively. For many borrowers, the ability to plan for the long term without worrying about fluctuating mortgage payments is the primary benefit.
- Fixed-rate mortgages protect borrowers from rising interest rates. Once you lock in your rate, you are safeguarded against any future rate hikes that could increase your monthly payments. This can be particularly advantageous in an environment where interest rates are expected to rise.
- Fixed-rate mortgages are straightforward and easy to understand. You will know exactly what they are getting, which simplifies the decision-making process.
- If you secure a fixed-rate mortgage during a period of low interest rates, you can benefit from those low rates for the entire term of your loan. That savings sometimes becomes significant over the life of the loan.
Cons
There are some potential downsides, too:
- Fixed-rate mortgages typically have higher initial interest rates compared to ARMs. This means that, at the beginning of the loan term, your monthly payments may be higher than they would be with an ARM.
- Fixed-rate mortgages offer less flexibility compared to ARMs. If interest rates decrease, you won’t benefit from the lower rates unless you refinance, which can involve additional costs and paperwork.
- In some cases, the higher initial rates of fixed-rate mortgages can lead to higher overall costs if you plan to sell or refinance your home within a few years. ARMs might be more cost-effective if you plan to make a move in the near future and this property is a stepping stone.
Pros and Cons of an Adjustable Rate Mortgage (ARM)
Pros
ARMs come with their own advantages, including:
- ARMs typically start with lower interest rates compared to fixed-rate mortgages. This means lower initial monthly payments, which might be the perfect fit if you want to buy now and anticipate an increase in income in the near future.
- If interest rates decline, the adjustable nature of ARMs means your interest rate and monthly payments could decrease without the hassle of refinancing, potentially saving you money.
- ARMs can be a good option for borrowers who plan to sell or refinance their home before the adjustable period begins. The initial lower rates can provide cost savings during the time you own the home.
Cons
There are also some potential disadvantages:
- The biggest drawback of ARMs is the uncertainty they bring. After the initial fixed-rate period, your interest rate and monthly payments can increase, sometimes significantly, depending on market conditions. This can lead to financial strain if you are not prepared for higher payments.
- ARMs can be more complex than fixed-rate mortgages. Understanding the terms, including adjustment periods, caps, and indexes, requires careful consideration and knowledge. This complexity can be challenging for some borrowers to navigate. The good news is, when you choose us as your lender we will be sure you’re confident in the details before you make a decision.
- If you plan to refinance before the adjustable period begins, there is no guarantee that you will qualify for refinancing or that interest rates will be favorable at that time. This uncertainty can complicate your financial planning.
Choosing Between an ARM and a Fixed Rate
Ultimately, there are a few factors you should consider as you decide between these two options:
- Risk Tolerance: Evaluate your risk tolerance. If you are comfortable with the possibility of rising rates and can manage fluctuating payments, an ARM could be a great way to take advantage of future market benefits. If you prefer certainty and want to avoid the risk of higher payments, a fixed-rate mortgage is likely the better option. Some people find that even if it means paying a bit more, the fixed rate is ultimately less stressful.
- Personal Finances: Assess your current financial stability, including your income, savings, and overall financial health. If you prefer stability and predictability, a fixed-rate mortgage might be the better choice. If you have flexibility and can handle potential changes in your monthly payments, an ARM could be advantageous.
- Long Term Plans: Consider how long you plan to stay in the home. If you intend to live in the property for a long time, a fixed-rate mortgage may provide the stability you need. If you plan to sell or refinance within a few years, an ARM might offer cost savings.
We are here to help answer whatever questions you have about buying a home or if a fixed rate or an ARM is a better choice for you. For over 20 years, we have been helping our clients find the mortgage that is uniquely right for their needs, and we are ready to help you too. Contact us any time to learn more.
