Friday, February 27, 2015 - Article by: Jason Vondrak - Prospect Financial Group, Inc. -
When buying a loan, it's important to understand your options and choose a program that's best for your unique situation. Today, homeowners have two main options: the fixed-rate mortgage (FRM) and the adjustable-rate mortgage (ARM). So what's the difference between the two? The names pretty much say it all. For the FRM, your interest rate is fixed for the life of the loan. With the ARM, your interest can change over time.
Fixed rate mortgages are very predictable. From the very beginning, you will know what to expect with and can be sure the interest rate of your mortgage will never change. However, payments tend to increase as the amount of time left in a mortgage term decreases. These larger payments are balanced by the FRM's usually low interest rates and smaller amounts paid over a loan's lifetime. Another benefit of an FRM is linked to the government program HARP, where homeowners with fixed rate mortgages have better access to the LTV feature of the program: almost 95% loan-to-value advantage than their ARM counterparts.
Adjustable rate mortgages are often associated with high risk, but not always rightly so. The life of an ARM can be described as this: in the beginning, during the initial fixed rate period, the mortgage rate stays the same. After this period ends the mortgage can change annually based on a present formula. The rate changes resting on two numbers, the margin and the index, which change over time. The addition of the margin and the index give you your new rate. So, how risky is it? Not as dramatically so as many people make it out to be.
An adjustable rate mortgage is a great option for those who don't plan on being in their house for long. The typical family moves every 5-7 years, especially those who have jobs that require relocation. Almost always, an ARM rate will be lower than a fixed-rate. If you'll be in your house less than 10 years, an ARM may be the best way to go.
With an ARM, your loan has an "adjustment cap," a limit on how far the interest rate on your loan can change. These limits vary depending on the ARM's initial fixed rate period but are generally reasonable, making an adjustable-rate mortgage less risky than many believe. ARM's also have predominantly lower closing costs and even come with no-closing cost options.
To answer the question which one is better, fixed or adjustable, is impossible without knowledge of a homeowner's individual situation. Have a conversation with your loan officer to evaluate which route would be best for you to take, and make sure you understand how each type works before making a decision.
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