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Fixed or Adjustable Rate Mortgage?

August 20th, 2013

Fixed or Adjustable Rate Mortgage?

With interest rates staying low and the economy rebounding, the housing market is looking up again. More and more people are looking to become homeowners, and pre-approval is the name of the game. Most sellers and real-estate agents won’t even look at you until you’ve been pre-approved for your mortgage, so this is the first step you need to take when home shopping. Knowing which type of mortgage you’re looking for will help to streamline this process and get you out in the market.

What is a Fixed-Rate Mortgage?

A fixed-rate mortgage is when the terms of the mortgage are set at the beginning, and do not change throughout the duration of the loan. A 30-year mortgage is the traditional fixed-rate choice, but 15-year mortgages have been gaining popularity as well. The interest rate in a fixed-rate mortgage is based on current market trends, and does not change over the course of the loan as the market fluctuates.

What is an Adjustable Mortgage?

Also known as an ARM, adjustable-rate mortgages are those where the terms of the mortgage can fluctuate over time as the market does. The initial interest rate with an ARM is usually lower than with a fixed rate mortgage, which will give you a lower monthly payment in the beginning. After a period of time, usually one to five years, the interest rate of an ARM rises to match or exceed the market rate, and can rise periodically throughout the life of the loan. There are guidelines as to how much the rate can rise at each adjustment period, but the first adjustment can increase your monthly payment significantly.

Which is Best?

The answer to the question, “Which mortgage type is best?” depends on your own unique circumstances and what your financial goals are for the future. If you have a steady income and plan to stay in your home for more than five years, then a fixed rate mortgage is something you should look into. While your initial monthly payment will be higher than it would with an ARM, you won’t have to worry about that balloon of interest rate looming on the horizon. You can plan your monthly finances around your mortgage payment and know that it will always be the same.

There are situations where an adjustable rate mortgage may be the smarter option. If you’re planning on being in the home for less than five years (maybe you plan to move or periodically change work), you can take advantage of the lower monthly payment that an ARM offers during this time. Often, the risk can pay off with the money you save during the initial, low-interest period. Careful and calculated planning is necessary to assure an ARM is your best option.

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