Should I Go With A Fixed Rate Or ARM Mortgage?

Last Updated 6/11/2015

Is a fixed rate or ARM mortgage the best choice for you?

Both fixed rate mortgages and adjustable rate mortgages (ARMs) have been popular with home buyers and for refinance loans. Both can have their pros and cons. So which is the right type of mortgage for you?

The Luxury of a Fixed Rate Mortgage Loan

Long term fixed rate home loans are often an under-appreciated luxury. Many countries around the globe simply don’t offer long term fixed rate mortgage loans. While the rates on 30 year fixed rate mortgages may be slightly higher than ARMs to account for the length of time lenders must commit their capital, there are clear advantages.

A fixed rate loan offers a lot of security. Borrowers are able to enjoy the confidence that they know exactly how much their principal and interest mortgage payment will be every month for the next 15 or 30 years. It gives them control and peace of mind. Never will they have to worry about being priced out of the homes they love and have invested so much in due to rising mortgage interest rates.

Navigating the Adjustable Rate Mortgage Menu

There are many different types of adjustable rate mortgage loans. It pays for borrowers to know the differences and their options in order to secure the best financing solution for their individual circumstances and to land the best deal possible.

The primary difference between different ARM loans is the period of time they are fixed for. Home loan shoppers will find ARMs advertised as “7/1, 5/1,” etc. The first number applies to the initial fixed period. The second number normally indicates how often the interest rate will be adjusted after that. So a 7/1 means the initial rate will be fixed for 7 years, and then adjust annually after that.

What is crucial for those that may hold their loans beyond the first adjustment is to know how rate adjustments are calculated. Which indexes are they tied to? Is this a stable or highly volatile index? What margin is added to the index to calculate your rate? For example; “Prime +4” would mean your rate will adjust to four percent over prime rate. There are also initial, annual, and lifetime caps which protect the borrower. A 6% lifetime cap means the highest your rate can go up is 6% over your start rate. Borrowers should be prepared for the worst case scenario, no matter how unlikely it is.

When is it Smart to Use an ARM Mortgage?

There are several scenarios in which home buyers and homeowners might find ARMs the right choice for a purchase mortgage or refinance loan.

Adjustable rate mortgages typically come with lower interest rates than fixed mortgages. This means enabling a first time home buyer to qualify for a bigger mortgage and more home. Of course this may only be sustainable for those anticipating rising incomes to keep up with rising mortgage rates. For example; a new doctor fresh out of medical school may be very confident in a rapidly escalating salary, and retiring student loan debt over the next 5 years. In this case an ARM could be a great match.

Those that plan to move within the next 10 years might also find an ARM the best choice. Why not benefit from the lower rate if you’ll be selling to relocate for work or to move up to a larger home anyway? However, all ARM mortgage borrowers should consider taking a slightly longer fixed period than they think they’ll need to provide them a cushion from unforeseen changes. So if you plan to move in 5 years take a 7/1 ARM. If you plan to move in 3 years, take a 5/1 ARM, and so on.