There are two main loan types a borrower can apply for when purchasing a new home. The two types are the adjustable rate mortgage, also known as an ARM loan and the fixed rate mortgage. The majority of people who borrow money for a home choose to finance their home purchase with a fixed rate mortgage. There are benefits to both fixed rate mortgages and adjustable rate mortgages, but most consumers prefer the predictability of a fixed rate mortgage.
Below are pros and cons for both loan types, as well as information on who may be a good candidate for each. Borrowers should familiarize themselves with each loan type before making a decision. With average loan terms of 15-30 years, it is imperative that home loan applicants choose the correct loan type for their situation.
Fixed Rate Mortgage Pros
- The interest rate is fixed for the life of the loan.
- There is more predictability.
- Borrowers know what their principal, interest and mortgage insurance payment will be every month for the life of the loan.
- Borrowers face less stress when interest rates rise.
- If rates go down, borrowers have the option of refinancing.
Fixed Rate Mortgage Cons
- If interest rates go down, borrowers will not be able to take advantage of lower rates, without refinancing.
- Initial interest rates will usually be slightly hirer than the ARM loan.
The fixed rate mortgage is a safe choice for home buyers. Budgeting and planning for the future is a lot easier, because the monthly payment is fixed for the life of the loan. Home buyers on a fixed income and those planning to take on additional debt in the future may find the fixed rate mortgage to be their only option.
First time home buyers are also likely to choose a fixed rate mortgage. Buying a first home can be a stressful experience. Home buyers often feel more comfortable knowing they do not face climbing house payments in the future.
Adjustable Rate Mortgage Pros
- When interest rates drop borrowers pay less interest.
- Rates are generally lower than a fixed rate mortgage during the initial fixed rate period.
Adjustable Rate Mortgage Cons
- After the initial fixed interest rate period, rates can increase significantly.
- Often, there is a large difference between the initial fixed interest rate and the highest interest rate possible.
- There is no way to know if interest rates will go up, down, or stay the same.
Adjustable rate mortgages may appeal to buyers planning to sell their home before the initial fixed interest period ends. An ARM loan may also appeal to investors that plan to “flip” the home soon after the purchase is finalized. Borrowers usually choose an ARM loan because the starting interest rate is almost always lower. Therefore, they will likely save money during the fixed rate period of the loan. More information on adjustable rate mortgages can be found at www.consumerfinance.gov, or by visiting www.fdic.com.
When choosing a mortgage, borrowers should consider all potential future financial hardships. Each borrower should carefully weigh the financing options available to them. It is essential for borrowers to take their future into consideration when choosing a loan.
The majority of consumers find the fixed rate mortgage to be the most logical option. There are many reasons borrowers prefer a fixed rate mortgage. Fixed rate loans provide predictability and security, which are important when committing to a long term financial responsibility.
More information about adjustable rate and fixed rate mortgage loans can be found at www.consumer.ftc.gov.