Adjustable-Rate Mortgage vs. Fixed-Rate Mortgage

Is a fixed mortgage or ARM mortgage right for you?

What is the best type of Seattle mortgage for your next home purchase or refinance? One of the bigger choices to make among loan programs and features is whether to pick a fixed rate mortgage or adjustable rate mortgage. So, what are the real pros and cons of each? How do you decide which is the best fit when it is time to take out a new home loan?

Fixed Rate Mortgages

Fixed rate mortgages have been a staple in the Seattle, Washington housing market for many years. Yet, they are actually quite rare worldwide. Many countries don’t offer them at all.

A fixed rate mortgage typically refers to a longer term loan, for which the interest rate is fixed for the duration of the loan. This may be 15, 25 or 30 years. Though other lengths are available as well. The result is also a fixed monthly principal and interest (P&I) payment for the life of the loan.

Many lenders and secondary market investors like these loans because they offer a consistent rate of return for a long period. Like a bond.

Although common, there can be pros and cons of this loan choice, depending on your current situation and future plans.

The Pros Of Choosing A Fixed Rate Mortgage

What are the advantages of a fixed mortgage?

Number one is probably the predictability of a consistent interest rate which will remain the same for as long as you keep this loan.

This also helps with financial planning. If you keep on making the payments as agreed, you know exactly how long it will take to pay off your home and own it free and clear of a mortgage.

With the interest fixed, the principal and interest portion of your monthly housing payment will remain the same each month too. This makes it easy to budget.

This can all bring a lot of peace of mind and confidence when purchasing a home or refinancing.

The Cons Of Choosing A Fixed Rate Mortgage

Of course, as with everything else in life, for every pro there can be a con. That can be true of fixed rate mortgages too.

One of the cons of being guaranteed a long term fixed rate is often paying a slightly higher interest rate for the privilege. This helps lenders offset any losses as interest rates change over time.

Another downside is that if you lock in a long term fixed rate, you may miss out on lower rates, which could automatically benefit you with an ARM mortgage. You would have to refinance your whole loan to take advantage of them.

It is also important to note that your taxes, insurance, association fees and maintenance are not fixed. These variable expenses can still rise and impact your overall monthly housing payment, even if your P&I stays the same.

When To Use A Fixed Rate Mortgage

Use a fixed rate mortgage when you are confident you will keep this loan for a good number of years, and want the peace of mind of fixed payments. Go fixed when you believe that interest rates could go up before you sell or refinance this property, and don’t want to risk this portion of your housing costs going up.

ARM Mortgages

An ‘ARM mortgage’ stands for Adjustable Rate Mortgage.

This means your interest rate can go up or down over time as the interest rate benchmarks it is tied to go up or down.

This is usually moderated with some caps. These caps limit how much your rate can go up or down at each adjustment period, and over the life of the loan. For example, there could be a cap of 2% at your first adjustment, 2% annually after that, and 6% over the life of your loan.

ARM mortgages come in varying lengths, just like fixed rate loans. They can be 10, 15 or 30 years long. You can also choose an introductory fixed rate period. The most popular include 2/2, 5/1, and 7/1 ARM loans. Meaning your initial rate would be fixed for 2, 5 or 7 years. Then it would adjust every one to two years after that.

The Pros Of Choosing An ARM Mortgage

There can be great advantages of adjustable rate mortgages.

One of the most notable is that they often offer a much lower initial interest rate. For example, you may save one to two percent in interest and enjoy a substantially lower P&I payment with an ARM over a fixed loan.

You also automatically benefit when interest rates go down. During a long period of declining rates you may see your interest and monthly payment decrease for years. When this happens you can choose to apply the difference to paying off your loan balance faster, or keep the money in your pocket.

The Cons Of Choosing An ARM Mortgage

There can be cons too. The most obvious being that if you stay beyond the initial fixed period, and interest rates go up, your rate and monthly payments can go up too. It offers little predictability in long term financial budgeting.

Another danger here is if rates simultaneously go up as property values come down, and there may be high unemployment. Like in 2008. This can put you in a situation where it is unattractive or impossible to switch to a longer term fixed rate.

When To Use An ARM Mortgage

Use an ARM mortgage when you want or need a lower rate now.

Future changes in interest rates may be irrelevant if you plan to sell or refinance this property in 10 years, but can enjoy a much lower rate intro period for the first 5 or 7 years.

Another reason to choose an ARM is if you want to buy a home now before prices go up further, and to avoid renting or moving costs, but anticipate your income rising over time. Perhaps you recently graduated or are working your way up as a doctor or have a young business which you expect to grow dramatically over the next few years. Then even if rates do go up in the future, your income will hopefully grow to match it, while you managed to lock in a lower house price, and have built equity in the property already.

Joe Tafolla
Joe Tafolla
Branch Manager at Seattle's Mortgage Broker

About the Author

Helping Seattleites buy their dream homes for over 15 years. Founder of Seattle's Mortgage Broker and author of Homeownership Simplified: The Truth about ZERO Down.

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