Buying a home is a dream of every individual. However, purchasing a property by cash is out of reach for many. For most of us, taking out a home loan is the most viable option. To own your dream home, leveraging a mortgage from a lender helps in covering the costs of buying real estate. However, it may sound simple to finance a home; the process can be quite complicated.
When you’re shopping for a mortgage, there’s a lot to consider. You need to consult multiple lenders, compare interest rates, and secure the best deal. But before you even start doing all this, there’s another important consideration. First, you need to determine whether to get a fixed- or an adjustable-rate mortgage (ARM). Now you may ask what the difference between these two is and how to choose the right one.
Home loans aren’t one-size-fits for all. There are several products in the market and you need to pick the one that best suits your specific requirements. The two primary types of mortgages are Fixed-rate mortgages and Adjustable-rate mortgages (ARMs). When you get a mortgage, you need to choose between these two by weighing their pros and cons. So, let’s understand these two types of mortgages to pick the right one for your current needs and future goals.
A fixed-rate mortgage has a fixed interest rate for the entire duration of the loan. When you take this type of mortgage, you pay the same monthly installment, irrespective of the prevailing economic conditions. Typically, fixed-rate mortgages carry a variety of terms such as 30, 20, and 15 years. In this mortgage, the lender charges a set rate of interest that does not change throughout the life of the loan. This type of mortgage is preferred by the homebuyers because it makes budgeting easier.
As compared to ARM, fixed-rate mortgages are easy to understand. When you choose a fixed-rate mortgage, you’re protected from unexpected interest rate increases. A sudden significant increase in the market interest rate will not impact your monthly mortgage payments. However, on the downside, if interest rates go down, you don’t get any benefit either. Although these loans are safe from sudden rise increases, the borrowers have to pay a price for this predictability. Unlike ARMs, fixed-rate mortgages start with a higher rate which makes your monthly payment also higher.
The ARMs are becoming popular because they have lower initial monthly payments. This type of mortgage carries a variable interest rate which means your monthly payment may change frequently over the life of the loan. The lending institutions offer a lower initial interest rate on an ARM and then the rate rises as time goes on. The fixed-rate period may vary from one month to 10 years. Once this initial term period is over, a new interest rate based on current market rates.
ARMs carry the advantage of lower rates than a fixed-rate mortgage, at least for the first three or seven years. Since these loans have low initial payments, it’s easier for borrowers to qualify for a larger loan. Moreover, if rates decrease in the future, the borrower can benefit from the lower interest rates without refinancing the mortgage. The major drawback of ARM is a sudden rise in interest rate. In case the market condition changes and the interest rate go up, your monthly payment may change significantly. ARMs are better for short-term loans because in the long-run the interest rate can surpass the fixed-rate loans. Furthermore, understanding the complex ARM terminology can be quite tricky.
Choosing between a fixed-rate and variable-rate mortgage requires careful consideration. Before you decide to commit to the loan, determine your budget, financial condition, finance needs, and other factors. If you need certainty and safety, a fixed-rate loan may better suit you. For those who need short-term financing, ARM can be the right choice.