The answer depends on several factors, including your financial situation. Let’s see the main differences between the two types of mortgages.
fixed rate mortgage
Two main components needed to compare fixed rate mortgages are the interest rate and the points. Points are fees paid to the lender at the beginning of the mortgage period. They are based on a percentage of the loan. So, one point equals one percent of the loan amount. Therefore, a $100,000 mortgage with 1.5 points would cost $1,500.
One lender may offer a lower interest rate than another, but the points may be higher, resulting in a less attractive loan. The important consideration here is the length of time you plan to hold the mortgage. The longer you plan to hold the mortgage, a higher point with a lower interest rate makes more sense. And, the less time you plan to stay in a home, the more likely you are to benefit from low or no points with a higher interest rate.
Also, be sure to ask your lender for the total of all fees involved. Lenders can add various fees that can add up quickly.
Some common fees are:
* application fee
* credit report
* property appraisal
* title insurance
* escrow fees
Request an itemized list of all fees in writing so you can compare mortgages fairly.
adjustable rate mortgage
Selecting the best adjustable rate mortgage (ARM) is basically impossible because there are some unknowns. However, you can look at some of the loan factors and, based on your situation, make a decision that you can live with.
The interest rate that an adjustable-rate mortgage starts with is called the introductory rate. This rate is the least important consideration when looking at ARM because it will change. The initial rate is often used as a claim rate to make you think the loan is on good terms.
The most important factors to consider when deciding on an ARM is an index formula and margin equals the interest rate. The index is what the lender uses to calculate your specific interest rate. Indices may differ in how quickly they respond to interest rate fluctuations. Some common indices used are Treasury Bills (T-bills) and Certificates of Deposit (CDs). The margin is a fixed number that is added to the index to obtain the interest rate. Margins are usually around 2.5 percent.
Another important consideration is how often the mortgage rate is recalculated. Some ARMs adjust monthly, while others only adjust every 6 or 12 months.
Additionally, rate caps are used to limit the amount the rate can change within an adjustment period. An adjustable rate mortgage that adjusts every 12 months may be limited to a 1 to 2 percent change up or down. There should also be a lifetime rate cap to limit the rate change over the life of the loan, which is typically around 5-6 percent higher than the initial rate.
Before accepting an ARM, you should calculate the payment at the highest rate allowed to see if you can handle the worst-case payment.
Lastly, other lender fees should be considered with a request for a written statement of total fees.
Fixed against ARM Payments
A fixed rate mortgage is just that, a fixed interest rate for the life of the loan. The payment will always be the same with no fluctuations, however the risk is that if rates drop significantly you may have to pay a higher rate.
ARM interest rates can fluctuate many times over the life of the loan, thus changing the amount of your monthly payment. ARMs offer potential interest savings because the initial rate is typically lower than a fixed rate. Also, if rates drop or stay the same, there will be ongoing savings compared to a fixed loan. But, if rates go up, an ARM will cost more than the fixed-rate loan.
Choosing a fixed rate vs. an adjustable rate mortgage
First, consider the risk you may take with changing your monthly payment amount. Do you have savings? Or are you fully budgeted with no emergency savings? If you can’t pay your ARM at the higher payment amount, you should avoid this type of loan.
Also, consider how long you plan to hold the mortgage. ARMs are generally better for a 5-7 year mortgage. If you plan to keep your mortgage for the long term, a fixed rate mortgage may be the best and least stressful option.
Lastly, if the thought of having an adjustable rate mortgage stresses you out…don’t! The stress is never worth the potential savings. And, if rates drop significantly, you may have the option to refinance at a lower rate anyway.