Your interest expense is one of the most important factors of any mortgage. As a driver of your monthly payment, your interest rate determines the amount of interest you will pay over time, which equates to a big chunk of the total cost of home ownership. As a borrower, one of the major decisions you will have is deciding between a fixed-rate and an adjustable-rate mortgage (ARM). But how do you know which loan is right for you?
The primary difference between a fully-amortized fixed-rate and ARM is that fixed-rate loans have the same interest rate throughout the entire life of the loan, whereas ARMs can change over time. The interest on a fixed-rate mortgage will usually be higher than an ARM but will not fluctuate. That means your monthly principal and interest will always be the same, providing stability and consistency. Some borrowers find that this allows them to more easily budget for the term of their loan.
The interest rate on an ARM may change over the course of the loan. A standard ARM will begin with a lower interest rate than a fixed-rate loan, but will change its rate based on the overall market index rate. The interest rate, and subsequently your monthly payment, can change multiple times over the course of the loan after the initial rate period. There are also combinations of fixed-rate and adjustable-rate loans, known as Hybrid ARM loans. These loans are fixed for a period of time, called the initial rate period, and then adjusted after that time. Examples of Hybrid ARMs are 3/1 or 5/1 loans, which adjust their interest rates after 3 or 5 years, respectively.
The lower interest rates offered by an ARM often allow qualified homebuyers to purchase larger, more expensive homes. However, since ARMs are influenced by the index rate of the larger market, rising interest rates could make it more difficult to budget in the long run. Some ARMs do take market fluctuation into account by capping the interest rate, known as the rate ceiling. If an ARM, or Hybrid ARM, is the direction you choose, make sure you know what your payments would look like if the interest rate hits this ceiling. Conversely, ARMs may also have a floor, or minimum interest rate associated with your loan. This could work against you if the index rate drops below your rate floor, as you will be stuck paying the higher interest rate.
Which Loan is Right for Me?
There are pros and cons to each type of loan and Equity Bank is here to help determine which one is right for you. Before meeting with your Equity Bank lending specialist, think about how long you plan on staying at your new home, and if you would be able to afford a monthly payment should interest rates go up. Also, do some research on current interest rates. If you plan on living in this house for the majority of the loan, and the current interest rates are low, then a fixed-rate loan may be for you. If you plan on moving in the near future, or the current interest rate is higher, than an ARM may be a better choice. While you can’t know the future with 100% certainty, talking over the pros and cons of fixed-rate and ARMs with your family and lending specialist will help you make the best decision for your situation.
Go Make Memories
Purchasing a home is full of anticipation and adventure. It’s the beginning of a new chapter, where lifelong memories are made with family and friends. At Equity Bank, our goal is to help you be well informed about all aspects of the mortgage process, so that your home buying decisions set you up for success. We know that every experience is different and we are here to help you every step of the way.