Fixed Rate Mortgages vs. Adjustable Rate Mortgages

posted on December 26th, 2012 | filed under: Uncategorized

An article by Samuel Scott Financial Group.

In this video, Debra Roberts, a Mortgage Advisor with Samuel Scott Financial Group, explains the difference between two common types of mortgages: Fixed Rated Mortgages and Adjustable Rate Mortgages. She breaks down the pros and cons for each type of mortgage and answer the most common questions borrowers have about these two types of home loans.

An Adjustable Rate Mortgage (ARM) is often called a variable mortgage because it tends to vary based on an index and a margin. It’s not uncommon to see an initial interest rate for an Adjustable Rate Mortgage to be at a discounted rate, usually lower than the rate for a fixed rate mortgage. Over time, the rates will fluctuate depending on whether or not general interest rates are going up or down.

On the other hand, a Fixed Rated Mortgage (FRM) will not vary over time. The interest rate and the monthly payment will remain the same over the entire life of the mortgage term, which are typically being 15 or 30 years.

There are a few questions that a Mortgage Advisor will usually ask to help a client determine which type of loan will best suit their financial and lifestyle needs. The answers a borrower gives to these questions influence the type of loan one chooses in the long run. These questions are:

  • How long do you plan on staying in the home?
  • What would you qualify for?
  • How risk adverse are you?

There are pros and cons to both Adjustable Rate and Fixed Rate mortgages. Working with a Mortgage Advisor, it’s important to look at the risks/rewards to each program and decide which loan will best compliment your personal situation.

Fixed Rate Mortgages

Pros: You can budget because the payment will remain the same over the entire length of the loan. You won’t have to plan for a fluctuation in interest, as it will always remain the same.  The bank is taking all the risk on interest rates.  If rates goes up (and since we are at historic lows, they will eventually have to) you are locked in a a great rate.  If rates somehow manage to drop even further, you can simply refinance your loan.

Cons: You may not have the flexibility of shortening your term as much as you would like to with an ARM. In the long run, you may pay more interest over the life of the loan.

Adjustable Rate Mortgages

Pros:  Typically a borrower will be able get into an Adjustable Rate Mortgage at a lower initial interest rate than a Fixed Rate Mortgage.  The main reason clients tend to choose an ARM is that you may end up with a lower monthly payment. Also, with an adjustable rate mortgage, you have a little more control on how much interest you are paying down each month and when you are paying it down.  This could lead to paying less in interest over the entire life of the loan.

Cons:  With an Adjustable Rate Mortgage, you are taking a risk that rates will rise on you. If that happens, your monthly payment could increase substantially. What was once an affordable payment could become a serious burden. If rates spike, the payment might get so high, so quickly that you have to default on the debt.

In today’s market, most buyers tend to lean towards fixed rate mortgages because rates are at an all time low. They appreciate the breathing room and peace of mind in knowing that their mortgage payments are predictable.

For clients who prefer the flexibility of an Adjustable Rate Mortgage, we recommend you talk to an experience loan officer about how to manage your risks.  You can find loans with restrictions and “caps” that limit how much an adjustable rate mortgage can actually adjust.  For example, you might have caps on the interest rate applied to your loan, or you might have a cap on the dollar amount of your monthly payment. You can even include a guaranteed number of years that must pass before the rate starts adjusting.

There are many, many different loan options available.  Each with different rates, terms and restrictions.  Rather than just shopping online and choosing a loan based on advertised rates, talk to a professional.  Share your personal financial goals and tell them about your lifestyle.  This way, your Mortgage Advisor can tailor a loan to fit your needs.

posted by Jeff DeChamplain

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Jeff DeChamplain