There are many types of mortgages available to homebuyers and refinancers, but most fall under the category of being either fixed rate mortgage or adjustable rate mortgage. With a fixed rate mortgage, borrowers lock in an interest rate that does not change for the life of the loan, and their mortgage payments stay the same each month. Adjustable rate mortgages (ARMs), on the other hand, are commonly hybrid loans that have a fixed rate for a designated term (usually between 3-10 years) and then transition to adjustable for the remainder of the loan. The fixed rate in the initial term of the ARM is generally lower than what is being offered with a straight fixed-rate loan.
The fixed rate loan is often considered the more desirable of the two, since most borrowers prefer to have a set mortgage payment each month over the uncertainty of an adjustable rate. But those willing to take a risk may opt for an ARM because the rate adjusts periodically based on a pre-selected index and margin and typically reset monthly or annually. If rates decline over the life of a loan, an ARM makes it possible to save money compared to the cost of a fixed-rate loan.
Benefits of a fixed-rate loan
Fixed-rate loans are ideal for homeowners who like to budget their money and aren’t planning on selling or refinancing their homes in the near future. The best time to lock in a fixed rate is when mortgage rates are low, so you’ll enjoy the low interest rate for as long as you stay in your home, even if rates go up.
Many borrowers shy away from ARMs because this type of loan was very popular in the mid-2000s when housing prices and interest rates were at their peak. The general belief was that homes would continue to appreciate and homeowners would always have the option to refinance or sell. But when the housing market fell, many borrowers with ARMs did not have enough equity in their homes to refinance and weren’t able to sell their homes for enough to pay off their mortgages. Many of them were left with no choice but to foreclose.
Benefits of an ARM
While ARMs are risky, that risk can sometimes pay off. Borrowers could end up saving money over a long period of time if interest rates remain steady or decline. Another situation where the hybrid ARM may be the right choice is if you have a definite plan to sell your house in 5 to 7 years. It is important to remember though, that if rates go up you may need to refinance to a fixed-rate loan which will require you to have at least 20 percent equity in your home.
There is no single loan that is right for every borrower. That’s why it’s a good idea to speak with your loan representative to find out what loan is best for you. Contact Cliffco Mortgage Bankers for more information and learn about your options!