Purchasing a house invariably is an interesting and nerve-racking at the same time. You might be thrilled with the idea of owning a home, particularly if you’re a first time home buyer. The thought of being a homeowner, all the things you will do to the house after you move in, the improvements you will make, kitchen upgrades, etc., these are all exciting, to say the least. However, the thought of financing and all the different types of home loans available out there in the market can be overwhelming and confusing. This is something that most first time home buyers need to understand and prepare for.
The two most common loan options you’ll see in the market are ARM or adjustable rate mortgages, and fixed rate mortgages or FRM. Each of them has its benefits and disadvantages. Which one suits your needs the best this particular time is something that must be tackled to determine which one is the best for you.
Fixed Rate Mortgage vs. Adjustable Rate Mortgage
Fixed rate mortgages are the most common and widely used type of mortgage. The interest rate on a fixed-rate mortgage does not change and remains constant for the whole term of the mortgage. A fixed rate mortgage has a significant advantage overall. First of all, a budget conscious person will find this type of loan most suitable for their needs. Since the interest rate is fixed throughout the life of the loan, a homeowner will have peace of mind knowing that the monthly mortgage payments will not change. It will be easier to come up with a budget that you can consistently keep, month in and month out. Needless to say, it is advisable for the conservative buyer to lean more towards a fixed rate mortgage when looking for a home loan.
Inversely, an adjustable rate mortgage works the other way around. A borrower can get a lower rate initially as compared to a fixed rate mortgage. You can buy a more expensive home that you might otherwise qualify for when getting a fixed rate. More home for your buck! But the interest rate is not set and will eventually change. With the change in interest rate comes along the change in monthly mortgage payments. With such type of loan, it’s tough to budget for future changes in monthly mortgage payments. Since the interest rate is directly tied to the bond market, the rate fluctuates all the time.
True, there is a cap that’s designed to keep the interest rate from changing extensively. Even the slightest fluctuation could be far too much for some homeowners to bear. Certainly, there’s also the chance that the rates will plunge. In such case, since your rate is adjustable, your mortgage payments will drop together with the interest rate.
When deciding whether a fixed rate mortgage or an adjustable rate mortgage is the best option for you, it is imperative that you consider several factors. Do you need a bigger and more expensive home or can you live with a smaller and decent house? Where do you see yourself years from now? Will you be making more money? Will you be moving up in the corporate ladder? How long do you see you and your family staying in the house you’re buying? Is it going to be for the long term or just temporary?
Determine if it is crucial to have the ability to arrange your finances per month without pondering if your home loan will rise or fall, but get a low-interest rate initially. Or would you rather pay a higher interest rate in the beginning but have a peace of mind knowing your mortgage payments will remain the same until such time that the loan has been paid off?
If you believe that you want the best of both worlds, keep in mind that you have other options too. If you think that the interest rate of a fixed rate mortgage is a bit too high right now, but you want the security of not having to worry about fluctuating interest rates, you may opt to buy the rate down in the form of discount points. Doing so will increase the total closing costs; therefore, you will need to bring more money to the closing table. However, it could be worth the initial cost of buying the rate down, especially in today’s market where the rate has been historically at its lowest level in years. More than likely, the interest rate will only go up from here.
If you decide to get an adjustable rate mortgage over a fixed rate mortgage, make sure you know exactly how high you can go with a fluctuating interest rate and still be comfortable with the monthly payments. Factor in the “wiggle room” in your monthly budget, just in case. This could be the difference between being able to afford to keep your house and losing it to foreclosure if the rate goes skyrocket in the future.