Fixed vs. Adjustable Rate Mortgages – What’s the Difference?

Buying a home can be an exciting but overwhelming process, especially when you try to sort through all of the mortgage loan options available on the market. Two of the most common options are a fixed mortgage and an adjustable-rate mortgage (ARM). Comparing ARMs vs. fixed-rate mortgages and knowing how these two loan options differ can help you save hundreds or even thousands of dollars over the life of your loan.

Fixed vs. Adjustable Rate Mortgage

Understanding the difference between a fixed-rate mortgage and an adjustable-rate mortgage is crucial when shopping for a home loan. In fact, the biggest difference between the two is how interest works with each type of mortgage. With a fixed-rate mortgage, your interest rate is locked in for the life of the loan and will never change — your rate will still be the same at year 10 as it was during year one.

With an ARM, your rate is locked in for a set number of years, and after those years are over, it turns into a variable rate that can change annually based on the actions of the Federal Reserve. Let’s take a 7/1 ARM, for example. With a 7/1 ARM, your interest rate will be locked for seven years and after the seventh year, it will turn into a variable rate set up to change annually. However, it’s important to understand that although you may be starting off with a lower interest rate, your rate will change after a certain number of years and can be even higher in the long run. In addition, the variable-rate can make it difficult to determine your monthly payment each year.

When it comes to fees and closing costs for each mortgage type, it is dependent upon the lender. At OVM Financial, your loan officer is ready to answer any questions you may have and assist you in discovering the best option for your own unique financial situation.

The Pros and Cons of Each

Fixed-Rate Mortgage

Pros

• Your rate does not change over the life of the loan.
• You’ll have the same monthly payment over the life of the loan.
• A fixed-rate mortgage is easy to understand and could make it easier to follow a payment schedule.

Cons

• There is a chance that the rate could drop and you’ll be stuck with a higher interest rate.
• You must refinance to get a lower rate.
• If you choose to refinance, you may have to pay closing costs and fees again

Adjustable-Rate Mortgage

Pros

• You could get a lower interest rate at the beginning of the loan.
• You can save thousands of dollars if you plan on selling before the fixed-rate portion is completed.
• There is no need to refinance to benefit from lower interest rates.

Cons

• Once the fixed-rate period is over, interest rates and monthly payments can be unpredictable.
• If interest rates rise, you may end up paying more in interest over time.
• They can be difficult to understand, especially if you’re unfamiliar with the prime-rate index.

Which option is better?

Like any financial decision, the right choice is based on your personal situation. However, there are a few indicators that can help you decide which one may be a better fit.

If the home you’re purchasing is going to be your “forever home,” you may be better off choosing a fixed-rate mortgage. This would be a better option because you’ll never have to worry about your rate changing and potentially driving your monthly payment up.

On the other hand, if you’re in a starter home or are anticipating moving within a few years, an ARM may be right for you, especially if you intend to sell before the initial fixed-rate period. This will help you save some cash over the life of having the loan because you’re starting with a lower interest rate and then selling your home.

The bottom line

Fixed-rate and adjustable-rate mortgages can each be extremely useful to home buyers with different financial and home loan needs. Still, it’s important to understand your own financial situation in order to determine which option is better for you. The option you go with could save you a lot of money in the long run!

As always, we’re here to answer any questions you have and help guide you through the process. Give us a call or start your application today.