Fixed Rate Versus Adjustable-Rate Mortgages
March 21, 2021
A Fixed Rate Loan is one with an interest rate that stays the same for the entire life of the loan. Your principal and interest amount changes from month to month as you pay down the loan, but the total amount you pay in interest is final, making it easier to budget and plan. With a fixed rate home loan, your amortization schedule is clear and complete.
An Adjustable-Rate Mortgage, commonly referred to as an ARM, gets more complicated. An ARM has an interest rate that changes over the loan term. The rate is set below the market rate for an initial, introductory period, which could be up to 10 years. After this initial period ends, the ARM will adjust.
To fully understand how an ARM works, there are a few key terms you will need to know:
- Adjustment Index: The interest rate adjustments on your ARM are dependent on an index that your lender uses as a benchmark. The FHA accepts market index figures of the Constant Maturity Treasury (CMT) index or the 1-year London Interbank Offered Rate (LIBOR).
- Adjustment Frequency. This is the between each interest-rate adjustment. For example, the FHA’s ARMs adjust annually.
- Margin: This is the number that is added to the index rate to determine your interest rate and is disclosed when you sign your loan.
Which One Works for Me?
There are pros and cons to both, the fixed rate loan, and the ARM. A fixed rate mortgage gives borrowers security of knowing how much they owe and the freedom to plan and budget for the future. However, this also means that they can be stuck paying a higher rate in a few years when the market rates drop, unless they choose to refinance.
With its lower interest payments, an ARM is considerably cheaper than a fixed rate mortgage, at least while the introductory fixed-rate period lasts. But borrowers are taking on the risk of a fluctuating market with rising rates in the future.
So which loan type is best? It comes down to each borrower’s needs and plan for the future. It helps to as yourself some questions when deciding.
How much can you afford?
If you are thinking about an ARM, it is important to be realistic. Run the numbers for a worst-case scenario and calculate your highest possible monthly payment. You might need to save during the initial low-interest period and put money away in case rates go up, or even make larger payments during that time so that the total loan is smaller when the interest rate adjustment occurs.
How long will you live in the home?
If this is your starter home, and you only intend to live there for a short amount of time anyway, it makes sense to sign up for an adjustable-rate mortgage and take advantage of the low rates during the introductory period.
In what direction are interest rates heading?
Talk to your loan officer and get their opinion on the market rates. Study trends and decide whether you can take on the risk.
Once you evaluate your needs and answer these questions for yourself, you will have a clearer idea of which option to choose. The FHA offers fixed and adjustable-rate loan options to borrowers and has the same qualification guidelines for both types. Contact your loan officer to take the first step!
------------------------------
RELATED VIDEOS:
Your Mortgage Payment Schedule Is Called Amortization
Information About the Balloon Payment
Reliable Borrowers Can Qualify for a Cash-Out Refinance
FHA Loan Articles
January 15, 2025Buying a condo with an FHA loan is an option some don’t consider initially, but it’s worth adding to your list of potential property types. FHA loans for condo units traditionally require condo projects to be on or added to the FHA-approved list. Still, changes in policy over the years allow borrowers to apply for FHA loans on condo units in projects not on the list on a case-by-case basis.
December 30, 2024When applying for an FHA loan, lenders will consider more than just your credit scores and history. They also look at other factors affecting your risk profile and the interest rate they offer you.
One factor is occupancy type. For FHA loans, this is straightforward because these loans require owner occupancy. Investment properties aren't eligible. While conventional loans may have different rates for primary residences, second homes, and investment properties, this isn't a concern with FHA loans.
December 18, 2024Did holiday spending get the better of you? Are you looking for ways to recover your spending plan as you search for a new home?
The holidays are a whirlwind of festivities, family gatherings, and gift-giving. But amidst the cheer, it's easy to lose track of spending. If you're aiming to buy a home in the near future, those extra expenses can have a bigger impact than you might realize, especially if you're considering an FHA loan.
December 17, 2024The Federal Housing Administration provides mortgage insurance on loans made by FHA-approved lenders, making homeownership more attainable for those who might not qualify for conventional loans.
While financial factors like credit score and debt-to-income ratio are key to loan approval, other non-financial aspects can also cause a denial.
December 11, 2024FHA loans, insured by the Federal Housing Administration, are a popular choice for many homebuyers, especially those who need a lower downpayment or more forgiving credit qualifying requirements. FHA loans are primarily intended for primary residences—homes that borrowers will occupy as their main dwelling.
