Fixed-Rate vs. Adjustable-Rate Mortgages: What’s the Difference?
Although it’s challenging to determine precisely how many people have mortgages, more than 60 percent of all homes in the United States are owned. In 2020 alone, real estate agents sold more than five million pre-existing homes. So if you’re in the market to purchase a home for yourself, you’re in good company.
Getting a mortgage for your home is a crucial part of the purchasing process. There are two primary mortgages available, which include fixed-rate vs. adjustable rate.
Which of the two options are best for your situation? It depends. Continue reading to learn the differences between these two mortgage types and how to determine which is the best option for you.
Fixed-Rate vs. Adjustable Rate Mortgages
When a mortgage is fixed-rate, it means your initial interest rates will be the same you pay for the duration of your loan. In other words, the mortgage part of your loan will never change, so you know exactly what to pay over the 10, 15, 20, or 30 years of your loan.
An adjustable-rate mortgage is also called an ARM. If a mortgage is an ARM, it means the interest rates can fluctuate at specific points during your mortgage. Generally, interest rate changes will happen every three, five, seven, or ten years during the loan’s lifetime.
The primary difference between these two is the interest rates. With one option, your rate is fixed and will never change. With the other option, the rate can be revised at specific points of your loan.
In either situation, you can use a mortgage calculator to help you determine the amount of your loan.
Benefits of Choosing a Fixed Rate Mortgage
The most significant benefit of choosing a fixed-rate mortgage is that the interest will remain consistent over the entire loan term. This makes it easy to budget your finances, even far into the future. However, it’s important to note that other things (like your property tax) could increase or decrease over time.
Another considerable benefit is that there are no prepayment penalties on fixed-rate mortgages. This makes them perfect for people who plan to remain in their new home for a long time.
Downsides of Choosing a Fixed Rate Mortgage
The most significant downside to choosing a fixed-rate mortgage is that the initial interest rates are higher when compared to those of an ARM. This means the general monthly payments tend to be higher.
Fixed-rate mortgages are also sometimes more difficult to qualify for. These downsides mean a fixed rate may not be the best option for people who only plan on living in their homes for a short period.
Benefits of Choosing an Adjustable Rate Mortgage
The most significant benefit to choosing an adjustable-rate mortgage is that initial interest rates will be lower when compared to those of fixed-rate mortgages. There is also a possibility of those interest rates decreasing at your loan’s revision periods. This makes an ARM an excellent choice if you know you’ll only remain in your home for a short period.
Downsides of Choosing an Adjustable Rate Mortgage
An adjustable-rate mortgage is a riskier option than a fixed rate. Although interest rates can decrease, they can also increase based on its linked index. Sometimes, interest rates can rise dramatically.
Since interest rates can vary, an ARM makes budgeting harder. It’s generally not a good loan option for people who plan to live in their homes long-term.
Who Is a Fixed Rate Mortgage Right For?
A fixed-rate mortgage is suitable for most people, which is why it’s significantly more common than an ARM. It’s also the most common option offered by lenders and is best for anyone who plans to remain in their home for a long duration.
Most people choose a fixed-rate mortgage because they aren’t comfortable with not knowing what their mortgage payments may be in the future. If you’re not satisfied with the risks of flexible interest rates, you should choose a fixed-rate mortgage.
In summary, a fixed-rate mortgage is suitable for people who:
- Want to know what their mortgage payments will be long-term
- Plan to remain in their home for a long time
- Aren’t comfortable with flexible interest rates
Who Is an Adjustable Rate Mortgage Right For?
Although a fixed-rate mortgage is suitable for most people, there are a few specific reasons why an adjustable-rate mortgage may be better for you. Primarily, these are the best choices for people who know they’ll only remain in their home for a few years. In addition, this type of loan is better for short-term homeowners because the interest rates start lower than fixed-rate options.
Additionally, an ARM may be suitable for people who know their income will increase in the future. Higher future interest rates may be an okay exchange for lower initial rates in this scenario. Finally, an ARM may be suitable for those who are comfortable with refinancing their loans in the future.
In summary, an adjustable-rate mortgage is suitable for people who:
- Plan to remain in their home only a few years
- Are comfortable with refinancing their loans if necessary
- Know their income will increase in the future
- Are okay with the gamble of flexible interest rates
Now You Understand the Difference
Now you understand the difference between fixed-rate vs. adjustable-rate mortgages. You can use this information to decide which of the two options is best for your unique situation.
If you still have questions, you can check out our other blogs posts. You’ll find articles on mortgages and related topics to help you learn more on the matter.