Fixed-Rate vs Adjustable-Rate Mortgage: Which Is Right For You?
Whether you're getting your first home loan or are re-entering the housing market after a long time, choosing a mortgage product is definitely a tricky affair. There are many factors to consider aside from your financial situation, such as the current interest rates, how long you plan to live in the house, and so on.
History shows that variable-rate mortgages are generally more affordable. However, Mortgage Professionals Canada reports that 77% of all mortgage loans are fixed rate, while 18% are variable or a combination of fixed and variable rates (5%).
One valuable thing you need to know are the key differences between a fixed-rate mortgage and an adjustable-rate mortgage. Here we've laid them out for you so you can evaluate each of the pros and cons before making that big decision.
TYPES OF MORTGAGES
Fixed-Rate Mortgage
A fixed-rate mortgage is a popular choice for many home buyers since the payment is fixed for the entire term of the loan. The most common terms are the 30-year and the 15-year fixed mortgages.
30-year fixed mortgages are an ideal choice for many borrowers who want to balance their budgets by freeing up some extra cash while also building a financial cushion. Compared to shorter loan repayment terms, the monthly payments can be much lower - so you can make progress on other goals and still have that backup plan in place!
If you've got the cash flow to spare, a 15-year fixed loan might be just the thing for you! It'll cut down your mortgage timeline from 30 years to an impressive half that amount of time - but be sure to crunch those numbers first and make sure it's a sustainable choice.
If you're feeling set in your career, ready to settle down and make a home for your family, then investing in a 30- or 15-year mortgage with fixed interest rates could be the perfect way to get started!
Pros and Cons
1. Your interest rates and payments remain the same.
With your mortgage rate and payments locked in, you're shielded from market turmoil- no more worrying about skyrocketing interest costs. It's the worry -free way to protect yourself against financial instability while staying on top of budgeting like a boss!
2. The terms are simpler to understand.
This is an advantage for first-time home buyers who may feel overwhelmed with the different loan terms and options. Fixed-rate mortgages are also virtually identical from lender to lender.
3. You can refinance if you want to take advantage of lower interest rates.
Since fixed-rate mortgage holders will be stuck with the same interest rates and payments, the only way to take advantage of lower rates later on is to refinance.
4. Your upfront costs may be more expensive.
Despite the security and stability that fixed-rate mortgages offer, they can be more expensive. The typical closing costs and monthly payments are often higher compared to an adjustable rate mortgage. Because of this, borrowers with poor credit may have difficulty getting a good deal using this mortgage term.
Situations where a fixed-rate mortgage might be best for you
You look forward to purchasing your forever home.
It's great for buyers who already want to settle down and stay in their home for the most of their lives or for people who plan to age in place. Instead of choosing an adjustable rate mortgage where they may end up paying more on interest due to varying rates, a 30-year or 15-year home loan with regular monthly payments is a great financial tool. It may help you assess your financial capability, plan your budget, and reduce the risk of paying more in interest over the life of your loan.
You want stability.
You don’t have to deal with anything unexpected when paying your mortgage payments, making budgeting easier. It decreases the uncertainty you can otherwise get if you use an ARM. Your housing payments don’t change so you can manage your finances better, especially since you also need to deal with other costs of homeownership.
Adjustable-Rate Mortgage
Mortgage interest rates for adjustable-rate mortgages change based on the prime rate. You will receive an interest rate based on a spread between the prime rate of your lender and your ARM rate. If the prime rate increases, the ARM rate will increase. You can expect your adjustable-rate mortgage to experience the following effects if interest rates increase:
The next time you pay your mortgage, you'll pay more interest
Consequently, your next scheduled mortgage payment will increase
The introductory rate may last for five years (5/1 ARM), seven years (7/1 ARM), and 10 years (10/1 ARM). These conditions may depend on what the lender offers and the specific terms of your loan.
The ARM rate adjusts annually based on the benchmark interest rate chosen by the lender. The most common benchmarks include the one-year London Interbank Offer Rate (LIBOR) and the weekly yield on the one-year Treasury bill. Other ARMs also have specific caps on how high or low the interest rate can go.
Pros and Cons
1. You'll have lower initial monthly payments.
If you take out an adjustable-rate mortgage, your initial fixed rate period can help save a ton of money compared to traditional loans! This could be 5 years, 7 years or even 10 – giving you cash in hand that can go towards furnishing and improving your new home. Plus it's possible with some loan terms to pay off the loan early without any nasty prepayment penalties - talk about flexible financial freedom!
2. It’s a riskier mortgage.
Before opting for an adjustable rate mortgage (ARM), you really should know what kind of risks it entails. Sure, the low initial interest may seem sweet - but after a certain amount of time passes, that fixed-rate can go right up! It's like taking your chances on a gamble... if all goes well and terms are favorable, then great news! If not? Then don't say we didn't warn ya'.
Home buyers should evaluate whether they can handle these associated risks and if there is enough wiggle room in their budget just in case rate rises in the future.
3. Your loan terms can be difficult to understand.
Shopping for a mortgage can be tricky, so if you’re just getting into the real estate game it's important to arm yourself with knowledge about adjustable-rate mortgages (ARMs). Unlike fixed-term loans where payments stay relatively steady over time, ARM agreements give lenders more leeway when deciding things like margins and caps. Borrowers l also have some flexibility whether they want to customize their agreement as well - but unfortunately this makes ARMS hard enough that sometimes even veteran buyers are baffled!
Situations where an ARM might be best for you
You're planning to relocate soon.
ARMs might make more sense and more appealing to younger, first-time home buyers who want to purchase a starter home. They are the ones who usually have plans to move to a new place after 5 to 7 years or don’t want to settle in one place for long, such as those who will need to relocate due to employment.
You want to get a larger loan to purchase a nicer house.
Lenders can use the lower rates and payments early in the loan’s term when qualifying borrowers. Through this, borrowers can buy larger homes than they could afford with a traditional fixed mortgage. If you’re this kind of buyer, the ARM might be the way to go. This strategy was popular among many borrowers during the housing boom.
You’re anticipating a lifestyle change.
If you’re expecting a significant salary increase or will be advancing in your career soon, an ARM may give you the most advantage. With the lower monthly payments, you can save money now while you have limited income. And then when your income increases just in time, you will then be comfortable with the prospect of making higher payments when your ARM adjusts.
An ARM is also a good choice if you want to keep your long-term options open and not be restricted with a fixed rate mortgage, where the payments will neither go up nor down.
Fixed rate vs ARM: Which one wins?
If the thought of adjustable-rate mortgage doesn't make you break into a cold sweat, consider taking advantage of low interest rates by getting one! It's usually cheaper than its fixed-rate counterpart and could save you some serious dough.
However, if you want peace of mind when it comes to your mortgage payments, then a fixed-rate loan is definitely the way to go! You'll never need to worry about what happens if interest rates suddenly increase - you can stick with that same monthly payment throughout.
Not sure if you should opt for a fixed-rate or variable-rate mortgage? A knowledgeable mortgage expert can help you decide which one will suit your individual needs best. Get the information and guidance to make an informed decision today!
Whatever your choice of mortgage, do not borrow more than you can afford, whether it is a fixed-rate mortgage or an adjustable-rate mortgage. Take into consideration your budget and goals before making a decision. You can visit our Listing page to see houses available in the market. Customize it according to your needs and budget. If you want in-depth guidance, talk to one of our local professional real estate agents. Here at Santa Sells Houses, we prioritize our clients' needs and wants. Contact us to book an appointment today.
