One of the questions you face when buying a new home for yourself is the problem of what type of mortgage you should get. Is an adjustable rate mortgage (ARM) right for you? Or should you get a fixed-rate mortgage?
An ARM is a mortgage where the interest rate is periodically adjusted up or down depending on the performance of an index a particular ARM is relating too. Not all ARMs’ interest rates depend on the same index. If you choose an ARM, your monthly payments will change throughout the life of your mortgage. If your interest rate goes up, so does your monthly mortgage payment. However, there is a maximum annual increase cap for each ARM. Additionally, there is also a cap on the total interest rate increase possible over the life of your mortgage. Still, this can be significantly more than the rate of a fixed-rate mortgage.
The fixed-rate mortgage on the other hand, has a fixed interest rate locked in for the life of your mortgage. Fifteen or thirty years from now, your interest rate and your monthly payment will be the same as in the beginning.
Nationwide, ARMs’ rates are usually lower than the average fixed-rate. However, if you opt for an ARM you gamble that the interest rate will not significantly increase. Otherwise your monthly payment will increase, and maybe even be higher than what you would have paid, if you had opted for the fixed-rate mortgage. As recent events in the mortgage and real estate market showed, those payments could get so high that you cannot afford to make them anymore. Of course the opposite is true, if rates decline as you luck out and might even end up with a lower than original monthly payment.
Shopping for the correct ARM for you could also turn out to be very complicated as there are not only different type of ARMS, but also different caps per ARM for the period, payment, and life-time increase. Additionally, the initial period where the initial rate and payments remain the same differs from ARM to ARM, lender to lender. The adjustment periods can differ from ARM to ARM as well as the margin rate the lender will add to the index rate to absorb minor index fluctuations during periods where the ARM rate cannot be adjusted. You have to be sure to be fully informed about every detail of the ARMs available to you, before making a decision.
Therefore, what mortgage type to get is an important question you should ask yourself. You have to take into account how long of a mortgage term you will need and whether you think the interest rates will go up or down during that time frame. Will your income increase enough to keep up with the possible rate increases, if you choose an ARM? Are there other things you might need a loan for in the future like a car, school tuition, or a boat?
If you want to stay in your home for five years or longer, you should opt for a fixed-rate mortgage. At the moment mortgage rates are low and you should lock in that rate. Additionally, you know with your current income, you will be able to afford the monthly payments.
However, if you only want to live in the home for less than five years, you might want to consider an ARM. Even though your interest rate will most likely rise in those few years, you have to keep in mind you start at a lower rate than with a fixed-rate mortgage, and that there is a maximum annual and life of loan interest rate increase. Over a short period of time, this will result in overall savings for you. However, you will have to make sure that your possible income two, three, or four years from now will be able to absorb any increases in the monthly payments.