The Difference Between a Fixed-Rate and Adjustable-Rate Mortgage (ARM) Loan
If you’re planning to buy a home, the whole process can seem a bit daunting. There are multiple things that first-time homebuyers need to figure out which makes the process confusing. Once you have found the perfect home, the next major task is getting a mortgage. Finding a mortgage and securing the best deal is the biggest challenge in your home buying journey.
When it comes to getting a mortgage, you need to compare different products to choose the best one. But before you do that, it’s better to understand the whole process and related terminology. Once you understand different loan options and features it becomes easier to choose the best option. If you’re in the market to get a mortgage, you will find two types of loans: fixed-rate mortgage and the adjustable-rate mortgage. You will find numerous varieties within these two categories but first, you need to determine which of the two main loan types will best suit your needs. So, let’s take a look at both these types of mortgages to understand which one is better for your specific financing requirements. Each one has some pros and cons which means you need to pick one by considering your budget, housing needs, and appetite for risk.
A fixed-rate mortgage carries the same interest rate for the entire life of the loan. In this type of mortgage, the monthly payment of principal and interest doesn’t change. This type is the most popular type of financing because rates and payments remain constant. It gives borrowers predictability and stability to make budgeting easier. The monthly amount of principal and interest may vary from payment to payment but the total payment remains the same. This type of mortgage protects customers from sudden significant increases in monthly mortgage payments if interest rates rise. For first-time buyers, fixed-rate mortgage is also simple to understand. However, there are some drawbacks also. If interest rates fall and you want to capitalize on this, you’ll need to refinance the loan and pay borrowing and other fees again. Also, these have higher starting interest rates than ARMs and qualifying can be an issue.
An adjustable-rate mortgage, or ARM, is a home loan in which the interest rate may go up or down. Under this type of mortgage, the interest rate can change periodically and your monthly payments can increase or decrease. In the beginning, the interest rate is fixed below the market rate but later the rate rises. The interest rate remains constant for a fixed period of time which can range anywhere from one month to 10 years. Once this fixed period is over, the loan resets to adjust the interest rate according to current market rates. Some borrowers prefer ARM because it is considerably cheaper than a fixed-rate mortgage, at least for the first three or five. The low initial payments also help the borrower to qualify for a larger loan. But on the downside, ARMs are much more complicated than fixed-rate loans. Also, rates and payments can rise significantly which can be a shock to your budget.