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You’ve found your dream home in the perfect neighborhood, but another important decision is just around the corner. Will you choose a fixed-rate mortgage or an ARM? And what do these terms mean anyway? Read on to better understand your loan options.
Image via Flickr by WoodleyWonderWorks
What is a Fixed-Rate Mortgage?
A fixed-rate mortgage is one with a fixed interest rate for the life of your loan. This fixed rate also means that your monthly principal and interest payments won’t fluctuate from month to month. Fixed-rate loans generally last 15, 20, or 30 years.
Why Choose a Fixed-Rate Mortgage?
The biggest advantage to fixed-rate mortgages is their predictability. While they can be more expensive than ARMs, particularly on the establishment, homeowners love knowing what they’ll be expected to pay each month. They’re an especially attractive option for people who intend to live in their homes for at least seven years, which is the time when fixed-rate mortgages can start becoming less expensive than ARMs.
Fixed-rate mortgagors also find budgeting easier because they always know how much they’ll need for home repayments. And if inflation soars, people on fixed-rate mortgages can feel confident that they won’t lose their homes.
Even people with a very basic understanding of finances can get a grip on fixed-rate mortgages. That makes them a great option for homeowners who prefer to keep things simple.
What is an ARM?
The ARM is short for an adjustable-rate mortgage. When you enter an ARM, its interest rate will be generally lower than a comparable fixed-rate mortgage for an introductory period of between five to seven years. After this honeymoon period, your interest rate will be determined by the market index. Interest rate caps help protect homeowners from substantial interest rate shifts. Just like fixed-rate loans, ARMs generally last for 15, 20, or 30 years.
Why Choose an ARM?
The low initial rate of an ARM can be very enticing to new homeowners. While there is a risk of higher payments later, many homeowners feel they’ll be better able to afford these payments in the future, when their job may be more secure or they’ve completed renovations. The lower repayments can even help families buy larger homes than they might afford on a fixed-term loan. Alternatively, an ARM can free up cash for people who’d prefer to build an investment portfolio rather than sinking a lot of money into their mortgage.
Financial markets rise and fall, and when they fall, people on ARMs benefit with lower payments. In contrast, people on fixed-rate mortgages need to refinance their homes and pay thousands of dollars in closing costs and fees to take advantage of housing market shifts.
ARMs are also a great option for people who plan to move houses within a few years. They can enjoy the honeymoon period, and then sell their property before ever risking higher payments.
The decision about which mortgage to accept is a big one, but once you understand your options, you’ll feel confident about making the right choice.