Adjustable Rate Mortgage vs. Fixed Rate Mortgage
When you need to get a mortgage, you are required to choose between adjustable rate mortgage and fixed rate mortgage. The choice you make can impact your borrowing cost significantly. Therefore, it is very important to weigh the advantages and disadvantages to make the right decision.
Both adjustable rate mortgage and fixed rate mortgage come with their own upsides and downsides. However, one of them might be more beneficial when your financial situation is taken into consideration. This article helps you in understanding their basic features and their pros and cons.
Let us get started.
Brief
Choosing between an adjustable rate mortgages (ARMs) and a fixed rate mortgage ultimately boils down to the following features:
1. ARMs generally involve lesser monthly payments at the start. However, the payments may change and in case they increase, it can be a costly affair.
2. On the contrary, Fixed Rate Mortgages begin with higher rates. The interest rate and monthly payment amounts remain unchanged through the life of the loan.
We are now done with the basics, let us explore these options further, and determine which loan works best for you!
Fixed Rate Mortgages
Pros
1. One of the major benefits of fixed rate mortgage lies in its safety feature. These loans require you to make payments with the same interest rate. The monthly payments do not fluctuate and you know how much you are supposed to pay by the end of the month. Hence there are no risks of payment-shocks and surprises. Therefore, the debtor is shielded from the sudden and consequential increases in the rates of interest.
2. Budgeting for homeowners is made easy with fixed rate mortgages.
3. They are easy to understand.
4. There is no great variation in the loan procedure and amounts between different lenders.
5. Provide flexibility with the term periods. They are available on a 15, 20, and 30-year basis.
6. If you choose a short term mortgage in lieu of a long term mortgage plan, the interest rates are lower in order for large amounts of principal to be repaid. Hence, such loan plans can significantly be a smaller burden overall.
Cons
1. Are you happy that you know how much money to keep aside every month for a mortgage? You pay a price for the predictability. As stated above, the interest rate to be paid is typically higher than the initial interest rate of an ARM. This also increases your monthly payment.
2. Qualifying for such mortgages becomes difficult when the interest rates are high as the payments are less affordable. People with a bad credit score suffer even more because of the spike in rates.
3. The trade-off for the low monthly payment option for long periods of time is the significantly higher overall cost.
4. In case you opted for a short term fixed rate mortgage, the monthly payments can be higher as the lender tries to obtain the principal amount at the earliest possible.
Adjustable Rate Mortgages
With ARMs, nobody can precisely predict what happens with the rates of interest. Even if you are able to predict the direction (higher or lower) accurately, it is hard to know the timing and speed of change of rates. The debtor basically shares the risk of uncertainty with his lender. In turn, you are allowed to pay lesser amounts at least in the initial years.
Pros
1. As stated above, the lower interest rates at the beginning (when compared to the fixed rate loans) result in low monthly payments as well. Therefore, homeowners can manage their cash flows better. If you are lucky enough, the rates might even fall and henceforth, you can pay lesser amounts.
2. One of the most significant benefits of adjustable rate mortgage is that they seem attractive to many borrowers, especially those with a low credit score. The low initial payments often help the debtors to qualify for a larger loan. In scenarios with lower interest rates, there will be no need to refinance the mortgage.
3. Overall, these loans are considered cheaper than the fixed rate mortgages.
Cons
1. They are dependent on the economy. If there is a surge in the rates of interest, an immediate increase in the monthly payment is observed. You might not be able to afford the new payment scheme, or you might end up remitting a significantly higher amount than you would have with a fixed rate mortgage. ARMs lead to changes in the monthly payments throughout the life of the loan, which might come as a shock if you are not prepared for it.
One such scenario which greatly affected the borrowers in this payment scheme is the mortgage meltdown of 2008. Most debtors faced a huge blow when their adjusted rate mortgage were regulated to higher rates and their payments skyrocketed.
2. If the ARM is held for long, the interest rate might eventually surpass the going rate for fixed rate mortgages.
3. ARMs are more complicated than fixed rate loans.
4. Some ARMs are structured in such a way that their interest rates nearly double in just a few years down the lane.
So, Which loan is right for you?
Try to answer the following questions first.
1. How long do you plan on living on the property?
2. How huge a mortgage payment can you incur today?
3. Can you still afford an increase in the interest rates and the resulting ARM?
4. In which direction are the rates of interest moving and do you expect the trend to continue?
Have you answered these questions? Great. Bear those answers in mind, read our tips, and decide what’s best for you!
Need for Certainty
If you need to adhere to a tight budget, any changes otherwise can prove disastrous. Therefore, a fixed rate loan will be a safer option. Although you might need to pay higher (in comparison with ARM), you will not be jolted.
Predictions
Although you might predict once or twice correctly, it is hard to accurately predict the timing, speed, and direction of rate movements always. If you believe that the rates are high and they can fall, an ARM allows you to save money in such drops without the need of refinancing it.
How long will you borrow?
A small time frame can make ARMs appear lucrative. For instance, if you decide on keeping your loan active only for 7 years, it might be comforting to know that ARMs tend to adjust only after 5 or 7 years.
Aggressive prepayment
Adjustable rate mortgage in Bergen County have relatively low monthly payments, except if there is a sharp spike in the rates. You can use them to prepay your mortgage and get rid of the loan balance quickly. Such prepayments can help you manage the risk of an unexpected hike in rates in the future. With a smaller loan balance, the rate of interest might not matter as much.
Bottom Line
Irrespective of the type of loan you select, take into consideration all the pros and cons we listed for you above, and avoid costly mistakes. Do not be deceived by lower interest rates of ARMs or the predictability of Fixed rate mortgage in Bergen County. Make a fully-aware choice and afford that dream house!
