Should you choose an ARM and a Fixed Rate Loan?
Confused about which home loan is right for you? In today’s competitive market, it’s important to know all of the facts before signing on the dotted line. When buying a home, you need to choose a home loan that works with your present, as well as your future, finances. Since choosing the right mortgage is important, let’s take a look at two popular kinds of loans: Adjustable Rate Mortgages and Fixed Rate Loans. But first, review the questions below and think about your answers as you read this article.
Questions to ask oneself before deciding to choose an ARM or Fixed Rate Loan:
- How long are you planning on living at this home? Less than four years, or five or more years?
- What’s more important to you:
- Stable mortgage payments, or
- A lower initial mortgage payment that may afford you some savings within the first few years of your loan?
- Do you qualify for a loan for the home you desire, or do you come up short?
- Do you expect you yearly income to continuously rise in the next few years, enough to compensate for a rise in mortgage payments?
Now that you’ve had a chance to think about your answers to questions above, let’s take a look at the characteristics, as well as the pros and cons of a(n):
- ARM or Adjustable Rate Mortgage: a loan whose interest rate can vary up or down; and
- Fixed Rate Mortgage: a rate that is locked in for the life of your loan.
Adjustable Rate Mortgages (ARMs) are definitely the riskier way to go because they put the homebuyer completely at the mercy of the interest rate of the moment. However, ARM loans do make sense to some depending on how long you are planning to live at the home you are buying. With an ARM, you are looking at lower mortgage payments for the first three or fours years, IF the interest rates don’t all-of-the-sudden increase. If interest rates do increase, the lender will typically increase the rate by two percent each year, topping out at a maximum of six percent over the entire life of the loan. (source: The Front Door) This can really affect your monthly mortgage payment, and someone who isn’t prepared for the increase could be in for a shock.
For example, let’s say that your loan starts out at 5.5 percent. Next year the percent could increase to 7.5 percent, then 9.5, then 11.5 and so on. In five years your interest rate would go from 5.5 to 13.5 percent. That’s a huge increase — in essence; your mortgage payment will double. This is assuming that interest rates are on the rise. If interest rates stay the same, you low monthly payment will stay low. However, without a crystal ball, it’s hard to know for sure what will happen.
However, ARM loans are a good idea if you are interested in getting a short-term boost to your finances. Some people opt for ARM loans because it allows them to buy a house at a lower interest rate, and for the first few years of the loan, it could save them a few thousand dollars a year. The money saved can be used to pay down credit cards or school loans, or even help with home improvement costs. However, it’s important to understand that eventually the interest rate will increase, as will your monthly mortgage payment. On that same note, many people opt for a one-year ARM loan, knowing that after one year, they’ll refinance. This allows the homeowner get more home for less money. However, again, this is providing you have the money to pay closing costs.
In comparison, Fixed Rate Loans are safe and dependable and make sense to someone who is looking to spend a considerable amount of time in the home they are purchasing. A fixed loan doesn’t change throughout the entire term of the loan. Going into the loan with a low interest rate allows you to lock in to the rate for the entirety of the loan.
Fixed rate loans are available for 10, 15, 20, or 30 year intervals, the most common being 15 and 30 year loans. With a fixed loan, your monthly payment usually stays the same; however property taxes and homeowners insurance can vary from year to year and could affect your monthly payment, but not by much. In addition, when you first begin paying off your loan, you are primarily paying interest. As the years progress, more and more of your monthly payment goes towards your principle balance.
Whatever loan you choose, it’s important to look at the big picture — knowing where your finances stand now, as well as in the years ahead, will help you determine which loan is right for you. |
