What Is The Difference Between a Fixed Rate Mortgage and an Adjustable Rate Mortgage?

Understanding Mortgage Types

There are many different types of mortgages, but the two primary mortgage types are the Fixed Rate Mortgage and the Adjustable Rate Mortgage (ARM). Then, there are many more options within these two categories, so it can get pretty confusing and overwhelming pretty quickly. The first step you need to take if you're wondering the which one to choose is to understand the differences between the two options to see which one will suit your needs best. Fixed Rate Mortgages will charge the borrower, which is you, a set interest rate which won't change during the loan period. The amount of principal and the interest paid each month will vary over time, but the payment will always stay the same. This makes your budgeting a lot easier and more streamlined. The main advantage of the fixed rate loan is that the borrower is protected from increases in the payments if interest rates go up. The only time it gets difficult to afford a fixed rate mortgage is when interest rates are high because the payments will be less affordable. There are also choices when it comes to the term of the mortgage ranging from 15 years to 30 years with 30-year mortgages having the lowest monthly payment making it more of a popular choice. That lower cost upfront also makes for a higher overall cost since one of the decades you're paying is mainly paying for interest. So while monthly payments on short-term mortgages are higher, they usually offer lower interest rates which will cost you less in the long haul.

The Complexity of Adjustable Rate Mortgages

Adjustable Rate Mortgages have a variable interest rate which usually set below market rate at the beginning of the term, and then the rate goes up over time sometimes even passing the current rate for fixed-rate loans. This makes ARMs more complex than Fixed Rate Loans, and you have to understand that there is the Adjustment Frequency which is the time between the interest rate adjustments. There are also Adjustment Indexes which are tied to a benchmark. Also, a Margin which is the rate you agree to pay when you sign your loan. There are also Caps which is the maximum amount the interest rate can increase within each adjustment period. Then the Ceiling is the highest that the adjustable interest rate can go during the period of the loan. ARMs do tend to be quite a bit cheaper than a fixed rate mortgage initially. Although, when you're choosing the right loan or mortgage for you, you have to explore all of your personal factors and then compare them with what is going on in current economics knowing that this could also change in the years to come.

Assessing Your Financial Situation

You should know what amount you can afford to pay today on a mortgage, and could you still afford that amount if the interest rate went up? Other factors like how long you will live on the property and what you plan on doing in the next 5 to 10 years also help to know. Along with other things like thinking about worst case scenarios and how you would navigate them. Write out what would be ideal for you and work through all of the different scenarios to make sense of how these mortgage types would work in your life. Talk with a financial advisor and see what advice they have to offer you as well. Sometimes having an objective perspective on your options can really help you decide what your next move will be. If you have the time to research, then take it before you leap into anything that you don't fully understand.