Adjustable Rate Mortgage vs. Fixed Rate Mortgage: The Key Differences
When shopping for a home or investment property, buyers are also responsible for choosing the right loan to fit their needs. A fixed rate mortgage and adjustable rate mortgage are the two most popular types of home loans.
Even before a potential buyer finds the perfect home or investment property, it’s essential to identify the best-suited loan products. Understanding the key differences between a fixed-rate and adjustable rate mortgage early helps buyers get prequalified. Which shows sellers you are prepared when it comes time to finalize the sale.
What are Adjustable Rate Mortgage Loans?
Often called an “ARM,” these types of home loans typically offer qualified borrowers low interest rates during the introductory period. After that time expires, the interest rate is calculated on a monthly or yearly basis against a standardized index.
For example, a 5/1 ARM has a five-year fixed mortgage rate period. Following the five-year introductory period, the annual interest rate is recalculated 1-time each year. People who select an adjustable rate mortgage enjoy low interest rates before any changes occur. These types of home loans may also provide options to refinance to a fixed mortgage if rates are on the rise.
What are Fixed Rate Mortgage Loans?
These types of mortgages offer qualified borrowers an interest rate that remains the same throughout repayment. Typically, with these types of loans, the monthly payment will not fluctuate, with the exception of taxes or homeowners insurance increases. In many cases, you are able to lock in a low mortgage rate for a term of 15 – 30 years for a small service charge.
Adjustable Rate Mortgage Pros and Cons
At a glance, the difference between these types of mortgage loans appears to be the fluctuating versus fixed interest rate. While that certainly is a key difference, there are long term effects of these differences. If you are mortgage shopping, consider the following
Adjustable Rate Mortgage Pros
- Low Monthly Payments During Fixed Rate Period
- Caps Placed on Adjustable Rate Increases
- Payments Could Decrease
Adjustable Rate Mortgage Cons
- Monthly Payments Could Increase
- Could Pay More Over Life of the Loan
- Difficult to Plan Monthly Finances
Fixed Mortgage Pros and Cons
It’s important to understand that one type of home loan is not necessarily better than another. The goal is to select the option that best serves your interests and finance goals. Weighing the pros and cons of a fixed rate mortgage is important before you decide on which loan option is for you.
Fixed Rate Mortgage Pros
- Easy to Plan Monthly Expenses
- No Risk of Interest Rate Increase
- Early Repayment Flexibility
Fixed Rate Mortgage Cons
- Cannot Take Advantage of Declining Rates
- Could Pay More Over Life of the Mortgage
- No Low-Rate Introductory Period
Is a Fixed Rate or Adjustable Rate Mortgage for You?
These types of home loans are not necessarily used for the same reasons. In other words, buyers may consider the potential savings over the life of the loan as just one factor among many.
A fixed rate mortgage may make perfect sense for community members who intend to put down roots, raise a family, or pursue career goals in an area. And a fixed rate loan may also fit into a long-term business plan that involves buying and operating an investment property.
An adjustable rate mortgage serves as an great option to finance short-term business goals. Developers and house flippers who buy and rehabilitate properties can take advantage of low interest introductory periods. By selling a real estate investment relatively quickly, investors can turn higher profits.
Another scenario that tends to make an adjustable rate mortgage a more favorable option involves relocation. When people know they will need to move for work, military service, or other reasons, an adjustable rate mortgage typically provides the lower monthly installment, all things being equal. In such cases, borrowers benefit from the introductory period with little concern about the adjustable phase.
How to Find the Right Mortgage Lender
Applying for an Adjustable Rate Mortgage or Fixed Rate Mortgage can be a relatively straightforward process. Consider checking your credit score by reviewing a free copy of your credit report. Clear up any errors or inconsistencies by reporting them to Equifax, Experian, or TransUnion.
If you are still unsure which mortgage is best for your financial situation, contact Allegiance today to speak with one of our trusted home loan professionals.
To learn more about the key differences between a fixed rate vs. adjustable rate mortgage and how it can effect your home buying process, review our "Complete Home Buying Checklist [10 Steps to Buying a House]".