The Difference Between A Fixed Rate And An Adjustable Rate Mortgage
The loan’s interest rate should be among the essential things to think about while looking for a mortgage loan to finance your home purchase. In terms of choices, you have two types of mortgages to choose from: those with fixed interest rates and those with variable interest rates. These two types vary. One has a constant interest rate for its whole life, while the other fluctuates over time.
You will have to weigh the benefits and drawbacks of each loan kind before deciding which one is right for you. Let’s start with the basics by defining the different types of loans:
- A fixed-rate mortgage has an interest rate that remains constant during the financing tenure. It is an installment loan compared to a personal or student loan with a set monthly installment.
- With an adjustable-rate mortgage, the interest rate may vary at any time. Initially, the interest rate is lower than a fixed-rate mortgage since the introductory period is short. However, when the introductory term expires, the interest rate becomes a “floating” rate, meaning it is subject to fluctuation depending on the state of the market at the time.
What Is The Difference Between An ARM And A Fixed-Rate Mortgage?
There are a few significant differences between fixed-rate loans and ARMs. Let’s find out more.
Margins
The interest rate on your mortgage can never go lower than the set margin in your loan documents. Whereas if the margin is set at 3%, it is applied to the existing index number that day of your rate adjustments.
Caps On Interest Rates
Rate caps on ARMs set a restriction on how much your interest rate may increase or fall in a given period and throughout the life of the mortgage. If your loan reaches its limit, it may not rise or fall in lockstep with the markets.
After your fixed-rate term ends, an initial cap is the highest percentage rise or reduction your rate may be in a single month. The most effective interest rate may vary between one adjustment period and is limited by a periodic cap.
A lifetime cap restricts the amount by which your interest rate may rise or fall from the introductory offer throughout your loan. Lenders shall represent initial, periodic, and lifetime ARM caps as a sequence of three integers distinguished by forwarding slashes. These numbers are what you refer to as your “cap structure.” So, an ARM with a 2/1/5 cap structure implies loan interest rates that may rise or decrease by up to 2% on your first adjustments up to 1% each subsequent adjustment. Finally, your interest rate cannot increase or fall by more than 5% up or down the actual rate throughout the loan.
Interest Rates
The interest rates on adjustable-rate mortgages (ARMs) are lower than those on fixed-rate mortgages, at least in the short term. Fixed-rate loans have a higher rate of interest because financial institutions must anticipate interest fluctuations over time. Lenders may be more indulgent with ARMs since their rates adjust to the changing market regarding initial loan fees.
Qualification Ease
To determine your eligibility for a loan, your lenders will compare how much money your family makes each month to how much money you spend. Such a ratio is known as your debt-to-income (DTI) ratio, and it has a significant impact on your ability to get a loan. An ARM may be more accessible if your debt-to-income ratio is high compared to a fixed-rate loan.
What Are The Similarities Between Arms And Fixed-Rate Mortgages?
There are a few similarities between adjustable-rate mortgages and fixed-rate mortgages that you may not expect.
Length Of Term
Both adjustable-rate mortgages and fixed-rate loans have the exact maximum loan term durations, regardless of their structure. The term duration refers to the number of years it will take you to repay the loan. For instance, both ARMs and fixed-rate loans typically have a 30-year duration.
Credit Requirements
Lenders look at something other than your income when determining whether to grant you an adjustable-rate mortgage (ARM) or a fixed-rate mortgage (FRM). Your credit rating has a significant effect on the capacity to get a loan of any kind. Your credit score is a number that represents your credit history—a three-digit number that shows how reliable you are in repaying your loan.
Generally speaking, a credit score of 700 or above is regarded as “good credit.” Higher credit scores increase your chances of getting an adjustable-rate mortgage (ARM) or a fixed-rate mortgage (FRM).
Is A Fixed-Rate Mortgage Right For You?
Here are a few advantages of going with a fixed rate:
Fixed Rates Are At An All-Time Low
Right present, both fixed and adjustable rates are at historically low levels. Because low rates indicate an economic decline, they’ve been trending lower as the US has battled the coronavirus pandemic. However, many lenders are providing fixed-rate contracts at an even reduced premium than adjustable-rate mortgages.
You Retain Your Reduced Rate Even If Mortgage Rates Rise
Because interest rates are at record lows, the odds are that if you select an ARM, your rate will increase later. Rates can’t continue to be this low indefinitely. However, with a fixed interest rate, you can lock in your low rate for the duration of your mortgage, even if interest rates in the United States rise.
Budgeting Is More Straightforward With Predictable Payments
Certain mortgage costs, including private homeowner’s insurance and property taxes, may vary over time. However, your interest stays relatively consistent each year, making budgeting for your monthly expenditures more straightforward.
Are Adjustable-Rate Mortgages Right For You?
ARMs have had some significant benefits for a long time. Lenders provided lower interest rates during the introductory range in length than typically provided for fixed-rate periods, making them an excellent option for individuals who only intended to remain in their house for a few years. If interest rates in the United States decrease, you may be able to get a better deal.
However, there aren’t too many advantages to selecting an ARM.
During the introductory rate period, lenders are pricing ARMs more excellent interest rates than fixed-rate mortgages. Considering interest rates are now so low, it’s doubtful that your ARM rate would drop in the future. Whatever else, it will almost inevitably increase.
Which Loan Is Right For You?
Fixed-rate mortgages are the superior bargain. However, if you’re thinking about getting an ARM, you must talk to your lender about your rates. Nevertheless, everyone’s circumstance is different; an ARM may still be a suitable match for you.
Allow Blake Mortgage to help you explore the possibilities available. You can rely on our expertise and experience to provide solutions to your financing needs—from home buying loans, refinancing deals, debt management, one-time close renovation, rehabilitation financing to bridge loan repayments, and reverse mortgages. Reach out to us and let us know how we can help.