Choosing a mortgage type is one of the largest decisions you make as a borrower. There is a big difference between a 15 and a 30-year term, not to mention between a fixed rate and ARM. Despite the numerous choices available today, borrowers still tend to choose the fixed rate mortgage and for good reason. It is the most predictable mortgage program available.
No Guessing Involved
Your mortgage payment is likely one of the largest bills you pay each month. Not knowing how much that payment will be from year to year can be nerve wracking. Rather than hoping that the interest rates do not rise, you can choose the fixed rate mortgage and know from day one the amount you owe each month. Knowing your payment can help you budget your money accordingly, taking the risk out of mortgage default. While you can always refinance out of an adjustable rate mortgage, you cannot predict the future. You do not know what your income will be like or what your credit score will be. If you do not qualify to refinance out of the ARM, you are stuck with the adjusted rate, whether you can afford it or not.
Locking in a Low Rate
Borrowers who are lucky enough to originate their mortgage when interest rates are low have a distinct advantage with the fixed rate mortgage. Locking in some of the lowest rates available enables them to save throughout the term of their loan. Having a low interest rate for a 30-year term can save you a significant amount of money on interest charges versus a loan with a higher interest rate.
Easy to Understand
A mortgage can be overwhelming. When you have an adjustable rate, there are so many variables at play. Not knowing what to expect can make things very overwhelming. Fixed rate mortgages, on the other hand, are the simplest mortgage to understand. You know right from the start what to expect. There are no formulas to understand or rates to follow. You also do not have to follow any interest rates, such as the Prime Rate to estimate where your next interest rate will fall. The rate remains the same for the term of the loan.
Refinancing is an option for any borrower after they purchase a home. You are not locked into the original mortgage you use for the purchase. However, refinancing costs money. It also restarts your mortgage.
Here is an example, you took out a 30-year mortgage to purchase a home 24 months ago. You made your 24 payments on time, but want to avoid the interest rate adjusting because you have an ARM. You decide to refinance into a 30-year fixed loan. This adds two years back onto the term of your mortgage. Granted, you likely did not pay a lot of principal in those first two years. The beginning payments of most mortgages mostly cover the interest, but there is some principal you likely paid down. Plus you knocked two years off the term. With a fixed rate loan at the right interest rate, you can eliminate the need to refinance, unless you need cash out of the equity in the future.
Easier to Qualify
Any mortgage program requires you to verify your debt-to-income ratio. You must prove you can afford the loan. With a fixed rate loan, you know the payment for the life of the term. This is the payment the lender uses to qualify you for the mortgage. An ARM, on the other hand, must use the fully indexed rate. In other words, they use the worst case scenario. This could mean a payment that is hundreds of dollars more than what you will pay initially. This may make it difficult to obtain approval for the loan. Even if you can afford the loan with no problem at the current interest rate, the lender needs to cover its bases and ensure that you can afford interest rate hikes in the future.
Afford More Home
Another benefit of the fixed rate mortgage is the ability to afford more home. This goes back to the fully indexed rate on an ARM. Because lenders often use this number for qualifying purposes, it could decrease the amount of loan they provide. Even if you get approved, it could be for less than you want. A loan without an adjustable rate, however, is kind of like you get what you see. You qualify based on the rate you will have for the life of the term. This may mean that you qualify for a larger loan.
Every borrower has different preferences regarding the type of loan they want. One thing to consider is your future plans. Will you move in the next few years? If it is before an adjustable rate will adjust, go for the ARM loan. This gives you a “teaser” rate which is often well below the fixed rate option. However, if you have no plans to move anytime soon, sticking with the rate that will not change might be the better option.
Another consideration to look at is your income. Are you on a fixed salary or do you have variable income? Variable income makes taking an adjustable rate riskier. There are too many unknowns in your future. At least having a stable mortgage payment can help you adjust your budget accordingly. Also think about the future. Do you plan on staying at the same job? Do you see yourself leaving work to start a family? These are things to consider when determining the type of loan you want. Choosing a fixed rate at least gives you some stability and allows you to make the right choices for your future.
The fixed rate loan continues to be the most popular option. Of course, you must decide for yourself. Contact several lenders and see what they have to offer. Ask to see both types of loans with quoted interest rates and fees so you can see which would offer you the best and most affordable deal for now and in the future.