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Mortgage and Refinance Information |
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Which is Better? Fixed-Rate or Adjustable-Rate Mortgages
The answer depends on several factors including your financial situation. Lets take a look at the main differences between the two types of mortgages. Fixed Rate Mortgage Two major components that are needed to compare fixed rate mortgages are the interest rate and the points. Points are fees paid to the lender at the beginning of the mortgage period. They are based on a percentage of the loan. So, one point equals one percent of the loan amount. Therefore, a $100,000 mortgage with 1.5 points would cost $1,500. One lender may offer a lower interest rate than another but the points may be higher resulting in a less attractive loan. The important consideration here is the length of time you plan to hold the mortgage. The longer you plan to keep the mortgage, a higher point with a lower interest rate makes more sense. And, the less time you plan to remain in a home you may be more likely to benefit from low or no points with a higher interest rate. In addition, be sure to ask your lender the total of all fees involved. Lenders can tack on various fees that can add up in a hurry. Some common fees are: * application fee * credit report * property appraisal * title insurance * escrow fees Request an itemized list of all fees in writing so you can compare mortgages fairly. Adjustable Rate Mortgage Selecting the best adjustable rate mortgage (ARM) is basically impossible because there are some unknowns. However, you can look at a few of the loan factors and depending on your situation make a decision you can live with. The interest rate that an adjustable rate mortgage starts off with is called the start rate. This rate is the least important consideration when looking at ARM's because it will change. The start rate is often used as a teaser rate to make you think that the loan has good terms. The more important factors to consider when deciding on an ARM is a formula of index and margin equals the interest rate. The index is what the lender uses to calculate your specific interest rate. Indexes can differ in how quickly they respond to interest rate fluctuations. Some common indexes used are Treasury bills (T-bills) and Certificates of Deposit (CD). The margin is a fixed figure which is added to the index to get the interest rate. Margins are typically about 2.5 percent. Another important consideration is the frequency in which the mortgage rate is recalculated. Some ARMs adjust monthly, while others only adjust every 6 or 12 months. Also, rate caps are used to limit the amount the rate can change within an adjustment period. An adjustable rate mortgage that adjusts every 12 months may be limited to a 1-2 percent change up or down. There should also be a lifetime rate cap to limit the rate change over the life of the loan which is usually around 5-6 percent higher than the start rate. Before accepting an ARM you should figure out the payment at the highest rate allowed to see if you can handle the worst case payment. Lastly, other lender fees should be considered with a request for a written total fees statement. Fixed vs. ARM Payments A fixed rate mortgage is just that, a fixed interest rate for the life of the loan. The payment will always stay the same without fluctuation, however, the risk is that if rates drop significantly you may be stuck with a higher rate. ARM interest rates can fluctuate many times over the life of the loan, thereby, changing your monthly payment amount. ARMs offer potential interest savings because the start rate is typically lower than a fixed rate. Also, if rates drop or stay the same there will be a continued savings compared to a fixed loan. But, if rates rise an ARM will cost more than the fixed rate loan. Choosing a Fixed-Rate vs. an Adjustable-Rate Mortgage First, consider the risk you can take with the monthly payment amount changing. Do you have savings? Or are you budgeted to the max without any emergency savings? If you can't afford to pay your ARM at the highest payment amount you should steer clear of this type of loan. Also, consider how long you plan to have the mortgage. Generally, ARMs are better for a mortgage of 5-7 years. If you plan to keep your mortgage for the long-term a fixed-rate mortgage may be the better, less stressful choice. Lastly, if the thought of having an adjustable rate mortgage stresses you out...don't do it! The stress is never worth the potential savings. And, if rates drop significantly you may have the option to refinance to a lower rate anyway. Jill Kane helps you find loans for all of your financial needs at Low Rate Loans
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