So, you've decided to buy a house—that's an exciting endeavor! Home buying is a complex process during which you will make several informed decisions that can have significant impacts. One of the largest decisions you will make is choosing the type of mortgage that is right for you. Before meeting with a lender, understanding the different types of mortgages and the difference between fixed- vs. adjustable-rate mortgages can help you immensely. Read on to learn about the advantages and disadvantages of these options and how to choose the best mortgage for you.
Fixed-Rate Mortgage Benefits
It's all there in the name. A fixed-rate mortgage gives you the same interest rate for the life of the loan. With this type of loan, rates are assessed at the time of purchase using the current housing market rates. If mortgage interest rates are high at the time you sign up for this option, you will be unable to change your rate if they drop without refinancing your mortgage.
Adjustable-Rate Mortgage Benefits
If you want more flexibility with your mortgage, you may consider an Adjustable-rate mortgage (ARM), but there are some significant differences. This type of mortgage usually starts at a fixed rate for a set period. The exact amount of time can vary, but you'll likely have a fixed rate for the first 5 to 10 years of your loan. After the fixed period ends, your interest rates and your monthly mortgage payments will be subject to fluctuation. ARMs are contingent on the housing market's strength, so when rates rise, your rate will increase and vice-versa. ARMs do have a rate cap and floor meaning your rate can only go up so high or so low. The rate cap is usually 5% above your initial rate at the time of closing. The floor, or how much a rate can decrease, is institution-specific, and typically in the 3% range depending on current market conditions.
Remember that the housing market could look very different ten years later, and your rate could significantly impact your mortgage payments positively or negatively. The challenging part is that the housing market can be unpredictable, and it's impossible to know whether those future rates will be higher or lower. For that reason, ARMs are considered riskier. But something to note is that you can refinance and switch to a fixed-rate loan down the line.
What You Need to Know About Your ARM
If you can predict the exact 30-year future of the housing market, you likely don't need a mortgage! But it's best practice to ask the following questions to know what to expect from your ARM before signing:
- How often will rates potentially adjust? Usually, it's every six months, but it can vary by lender.
- How much can rates and your payment go up or down? Is there a cap on how high? What about a limit on how low? Don't just accept a yes or no; ask for the specifics of the "worst-case scenario."
- How long does the introductory period last?
Fixed- vs. Adjustable-Rate Similarities
Knowing the similarities between these loans is also vital to making the best choices for your needs. Similarities between these loan types include the following:
- Both mortgage types have a standard 30-year loan term period.
- Both mortgage types can be refinanced. And when refinancing, you can switch to the other loan type.
- Both have similar requirements to qualify, including good credit.
Why a Fixed-Rate Mortgage Could Be Right for You
Fixed-rate mortgages are generally the more popular option. But why is that? The popularity of a fixed-rate mortgage is because many people appreciate the predictability of this financing option. Keeping the same monthly payment means you don't have to worry about the market causing drastic changes to what you pay. A fixed-rate loan makes it easier to create and stick to a budget. Additionally, this loan type makes it easier to plan your future as life changes occur, which will likely happen over 30 years.
Fixed-rate mortgages may also be preferable for those planning to stay in the same house longer. Both fixed and adjustable mortgages typically offer standard loan terms of 15 and 30 years, and those who choose the fixed option are more likely to stay for a significant duration. Ask yourself: Are you searching for your forever home or just a home for right now?
As you explore your options, you must also be aware of the downsides of a fixed-rate mortgage. While fixed rates offer convenience, your rate could be higher than those with an ARM. Higher interest rates can make this mortgage type more challenging to qualify for during inflationary periods like the one we're in right now.
Why an Adjustable-Rate Mortgage Could Be Right for You
Overall, the requirements for both types of mortgages are quite similar; however, it's usually easier to qualify for an adjustable-rate mortgage than a fixed-rate one. But what are the other reasons an ARM might be the better choice for you?
An ARM's initial rates are often lower than a fixed mortgage rate. Those savings can add up quickly, even if they only last for the first few years. With lower introductory rates, you can potentially qualify for homes in higher price ranges.
If your home purchase is more of a temporary stepping stone for less than five years, an ARM may be your best option. Since you plan to leave before the introductory period ends, you could get the benefits of an ARM with the stability of a fixed-rate mortgage.
If the housing market has high rates when you sign, choosing an ARM also provides you flexibility, as it means you won't be permanently locked into those rates. Plus, if you'd like to pay the principal off sooner rather than later, the lower initial interest rates on an ARM make it easier to build equity faster.
How to Decide Between a Fixed- vs. Adjustable-Rate Mortgage
So, you've learned the fundamental differences and similarities between the two mortgage types. Now, questions to ask yourself include:
- What's the most important thing you're looking for in a mortgage? Is it predictability? Or is it having the lowest payment?
- Are you more drawn to the safe bet? Or would you instead take a risk for the chance that it may pay off?
- What does the housing market look like currently? What are the future projections?
- What are the specifics of the houses you're interested in?
- How long do you see yourself residing at this particular home?
Take a good, hard, honest look at your budget, credit history, long-term goals and plans, and priorities.
Additionally, it's important to remember that you may have the potential to refinance your loan to make changes down the road. Depending on your future situation, if you still qualify for a mortgage, refinancing can allow you to switch mortgage types and you may even qualify for a lower rate!
If you're still unsure which mortgage option best fits your situation, don't hesitate to ask for help. You can consult with a home loan expert at your financial institution. No matter what, it always helps to get an expert's opinion.
In addition to choosing between a fixed- vs. adjustable-rate mortgage, you'll have to select a mortgage lender. Contact us at Vermont Federal Credit Union, and we'll help make your home ownership dreams a reality. You can find more information about mortgage options and becoming a Vermont Federal Credit Union member. You'll also find numerous home loan-related resources, including a step-by-step guide to the home-buying process.