Choosing a mortgage is one of the biggest financial decisions you'll make, and one of the first choices is between a fixed-rate mortgage and an adjustable-rate mortgage, often called an ARM. Both can be good options, depending on your plans, your budget and how comfortable you are with the possibility of changing payments.
A fixed-rate mortgage has an interest rate that stays the same for the entire life of the loan, commonly 15 or 30 years. Your principal and interest payment never changes, which makes budgeting simple and protects you if interest rates rise in the future. That stability is why fixed-rate loans are the most popular choice among American homebuyers.
How adjustable-rate mortgages work
An adjustable-rate mortgage starts with an initial fixed-rate period, often five, seven or ten years. After that, the rate adjusts at regular intervals based on a benchmark index plus a set margin. ARMs are often described by these terms; for example, a 7/6 ARM has a fixed rate for seven years, then adjusts every six months.
ARMs typically offer a lower starting rate than comparable fixed-rate loans, which can mean lower payments in the early years. Most ARMs also include rate caps that limit how much the rate can increase at the first adjustment, at each later adjustment and over the life of the loan. Understanding those caps is essential before choosing an ARM.
The main risk of an ARM is uncertainty. If rates rise after the fixed period ends, your monthly payment could increase significantly. Some borrowers plan to sell or refinance before the adjustment period begins, but refinancing depends on your credit, your home's value and future rates, none of which are guaranteed.
A fixed-rate mortgage often makes the most sense if you plan to stay in your home for many years, want predictable payments or expect rates to rise. An ARM may make sense if you expect to move or pay off the loan before the first adjustment, or if your income is likely to grow and you can comfortably handle higher payments.
Look beyond the rate
When comparing loans, look at the annual percentage rate, closing costs, points and the total cost over the time you expect to keep the loan. Getting quotes from more than one lender on the same day can help you compare fairly, and a mortgage advisor can walk you through each option.
Finance Zone Point helps homebuyers and homeowners in Evanston and throughout the Chicago area compare fixed and adjustable options and choose a mortgage with confidence. Contact us for a free mortgage consultation.