Most advice tells you to go with a fixed-rate mortgage over an adjustable-rate mortgage because of the risk involved. While the fixed-rate mortgage is always the safe bet, there are circumstances where an adjustable-rate mortgage can actually make sense for a homeowner. Let’s discuss both mortgage options in a little more detail.
A fixed-rate mortgage has an interest rate that stays the same throughout the entire life of the loan. The rate benchmark for a 30-year fixed-rate mortgage is currently 3.8%, according to BankRate.com.
The benefit of a fixed-rate mortgage is assurance. You know exactly how much your monthly payments will be until you pay off the mortgage. The security of a fixed-rate mortgage also presents a setback.
If mortgage rates decrease in the future, you’re stuck with the same rate unless you refinance. We offer a streamlined refinance process. If you’re on the hunt for a more competitive mortgage rate, contact us today to prequalify.
An adjustable-rate mortgage (ARM) has an interest rate that fluctuates based on a mortgage index. Since interest is variable, your monthly payments will change throughout the loan term. Although, there’s a cap on how much your rate can increase over time.
An adjustable-rate mortgage starts out with an introductory period, usually from 1 to 7 years depending on the loan product you choose. During the introductory period, the interest rate stays the same. Once the introductory ends, your rate changes at a frequency called the adjustable period.
Adjustable-rate mortgages are enticing because they’re initially cheaper than fixed-rate mortgages. According to Bankrate.com, the average 5/1 adjustable-rate mortgage is 3.24%. The expression 5/1 means the loan has a 5-year introductory period and the rate adjusts once per year after it ends.
If the mortgage index makes a move in the future, it’s most likely going to trend upward since mortgage rates are currently at a low.
For this reason, home buyers gravitate towards the fixed-rate mortgage, but there are a few instances where you can benefit from an ARM.
If you plan to purchase a home and sell it within 1 or 2 years, you can take advantage of the low-interest payments for the first few years and sell before you encounter a rate change. You can also go into an adjustable-rate mortgage with a plan to refinance to a fixed-rate mortgage before interest starts adjusting.
Let’s look at an example comparing a fixed-rate and adjustable-rate mortgage:
A $500,000, 30-year fixed-rate mortgage at 3.8% interest will have payments of $2,330 per month. A $500,000 adjustable-rate mortgage with a 5 year introductory period at 3.24% interest will have initial payments of $2,173.29 per month. During the 60-month introductory period, the adjustable-rate mortgage offers $9,403 in savings.
Ultimately, you can’t predict the future.
Even if you go into an adjustable-rate mortgage with a strategy, the plan can derail. There will always be some degree of risk involved, so weigh the pros and cons carefully before making a decision.
Interested in learning more about your mortgage options or prequalifying for a home loan?