When you are buying a home or getting set to refinance your current home loan, you may be faced with different mortgage loan decisions. One could be whether to get a fixed-rate mortgage or an adjustable-rate mortgage (ARM).

The Differences

First, you should understand the differences. A fixed-rate mortgage will give you one fixed interest rate throughout the life of the loan. Adjustable-rate mortgages will usually start off with a fixed interest rate, but the rate itself will reset periodically (usually each year and sometimes monthly) based on the outstanding balance and other market forces.

An adjustable-rate mortgage can be tempted because it’s usually less expensive early on in the loan. However, it is less predictable over the long run. A fixed-rate mortgage is definitely the safer bet because you know the interest rate will stay set no matter what, whether it’s a 7-year, 15-year or 30-year fixed mortgage loan.

Let’s take a look at some advantages and disadvantages of each:

Adjustable-Rate Mortgages (ARM)

Advantages:

  • Usually lower rates early on.
  • Borrowers can qualify for bigger loans because of initial lower payment schedule.
  • If prevailing rates go down, loan will self-adjust (no need to refinance at lower rate).
  • Save money at beginning of loan.
  • Worth considering if you only plan to live in the property for a short period of time.

Disadvantages:

  • Rates can go up significantly if market conditions dictate.
  • First adjustment can be very large because initial rate caps do not apply.
  • ARM loans are very complex.
  • Lenders can get more creative, which isn’t always good for borrower.
  • Very unpredictable from year to year.
  • May end up costing more over time if rates keep going up.

Fixed-Rate Mortgages

Advantages:

  • Interest rate remains constant, despite prevailing market conditions.
  • Easier for borrower to budget because base mortgage payments don’t change.
  • Very simple and easy to understand.
  • Predictable and secure interest rate throughout life of loan.

Disadvantages:

  • If rates do go down, borrower needs to refinance to get lower interest rate.
  • More expensive early on because of set rate/payment schedule.
  • Less competition between lenders because they can’t get as creative (again, could be good protection from a lender trying to get too creative with a bad ARM loan).

Adjustable-rate mortgages were very popular in the 1990s and early 2000s and were partly to blame for the real estate crisis that peaked in 2008. People were buying more home than they could afford. As interest rates rose, they couldn’t afford payments and were priced out of their homes.

More regulations are in place now to help mitigate this concern, but adjustable-rate mortgages will always be somewhat of a gamble. Interest rates as of the writing of this article remain low, but they are expected to rise in coming years. A fixed-rate mortgage will always be a safer bet unless you are only planning to stay in the property for a short period or you plan to flip it. In these cases, the lower early costs of an ARM may be worth the gamble.

Make the Right Decisions

Before you make any mortgage loan decision, make sure to avoid common mortgage mistakes and speak with an experienced mortgage professional who will give you the information you need and explain your options to you. A good loan officer will take the time to understand your needs, get you pre-approved for a loan you can actually afford and get terms that will be most favorable for your specific financial situation.

At Transparent Mortgage, we believe in 100% transparency in every mortgage transaction we conduct. We’ll show you your options and give you the insight you need to make sound home loan or refinancing decisions. Give me a call today at (619) 929-0199 and I’ll be happy to answer any mortgage questions you have.

Beau Hodson

Beau Hodson

About the Author Since 2003, Beau has been a mortgage professional and is a leading mortgage broker and lender in San Diego. As Founder and Senior Mortgage Advisor at Transparent Mortgage, he is truly committed to serving the needs of his clients and raising industry standards for integrity and transparency.