Mortgages are not one-size-fits-all and to choose the mortgage that is best for you, you should have a fundamental understanding of what makes one mortgage different from another. A good place to start is with understanding the difference between fixed-rate and adjustable-rate mortgages.
There are many different types of mortgages that fall within these two categories, but understanding the fundamental difference between fixed-rate and adjustable-rate mortgages is essential to understanding which of the various types of mortgages is right for you.
Fixed-rate vs. Adjustable-rate Mortgages
A fixed-rate mortgage, as the term implies, is a mortgage with an interest rate that remains “fixed” for the life of the loan, usually 15 or 30 years. For instance, if you obtain a 30-year fixed-rate mortgage, and your monthly payment of principal and interest is $2000 in the first year of the loan, you will still have the same interest rate and still be paying the same amount of principal and interest every month in the 10th, 20th, and 30th year.
An adjustable-rate mortgage (ARM), on the other hand, is a mortgage with an interest that can be raised or lowered, depending on the current market conditions. In other words, with an ARM, your mortgage payment may vary from year to year. The most common type of adjustable-rate mortgage combines the characteristics of both a fixed-rate mortgage and an adjustable-rate mortgage to create what is referred to as a Hybrid ARM.
What is a Hybrid ARM?
A hybrid ARM is characterized by a 30-year mortgage term and an initial fixed interest rate for a set period—5, 7, or 10 years—then the rate becomes adjustable thereafter. For instance, a 5-year ARM, also called a “5/1 ARM”, will have a fixed interest rate for the first 5 years. Since the interest rate is fixed for the initial 5 years, your mortgage payment will also remain the same for these 5 years.
But, after the 5th year, the mortgage’s interest rate will be adjusted up or down every year for the remaining 25 years to reflect changes in the financial market. This means that your monthly mortgage payment will also change annually as the interest rate changes. Therefore, you must be able to make higher mortgage payments if the interest rate rises from one year to the next.
Is a Fixed-rate or Adjustable-rate Mortgage Best For You?
To determine if a fixed-rate or adjustable-rate mortgage is best for you, ask yourself some important questions:
- Do you prefer the stability of knowing exactly what your mortgage payments will be month after month, for the next 10, 20, or 30 years?
- Do you plan to remain in the home indefinitely, or for a long time?
- Do you want to be protected from changes in the financial market that can cause your monthly mortgage payment to increase over time?
If the answer is yes to any one of the questions above, then a fixed-rate mortgage may be best for you. Especially, if you are planning on staying in the home long-term and perhaps even passing it on to your children after you pass away.
When considering an adjustable-rate mortgage, ask yourself the following:
- Is this only a starter home, or one that you don’t plan to live in for a long period of time?
- Are you expecting interest rates to decline over time?
- Will you still be able to make the monthly payments if they go up after the fixed-rate period ends?
If the answer is yes to any of these questions, then an ARM may be best for you, as it can save you a good deal of money upfront. This is because the interest rate during the fixed-rate period of an ARM is often lower than the interest would be for a fixed-rate mortgage.
Conclusion
When choosing a mortgage to purchase a home, knowing the difference between a fixed-rate and an adjustable-rate mortgage is essential. Furthermore, it is important that you do a bit of “homework” before looking for a mortgage.
Set a budget for the purchase, research the prevailing interest rate, use an online mortgage calculator to estimate your monthly mortgage payment, and be honest with yourself about what you can afford to pay for a home.
Remember, you are not only purchasing a home for your family, you are also taking on a financial obligation that you may have for the rest of your life. So, choose wisely.
Consult with an Experienced Estate Planning Attorney
You can do estate planning on your own, but an experienced professional can advise you of your rights, obligations, and options to achieve your estate planning goals. Working with an experienced estate planning attorney is the best way to ensure that you have the right documents in place to provide for yourself and your family.
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