Adjustable Rate Mortgage vs. Fixed Rate Mortgage

Girl comparing an apple and an orange
When individuals or families decide to venture into the world of home-buying, particularly for the first time, they often find themselves under a constant barrage of foreign concepts. Contracts, listing agreements, addendums, escrow, refinances — every aspect of a real estate transaction seems to be stuffed with new and often unfamiliar terms. However, if a new homebuyer could get a grasp of just one thing, they should learn the about the two primary home mortgage types, and which of those types to choose.

The two main players are adjustable- and fixed-rate mortgages. Some feel the adjustable route is volatile and dangerous, leaving fixed as the only prudent and wise choice. Other homebuyers and real estate investors study the interest rate market and choose adjustable if the trends are in their favor. Only after acquiring knowledge of both of these forms of home loans can a prospective homebuyer make a wise and informed decision.

Adjustable-Rate Mortgages

Adjustable-rate mortgages, or ARMs, have a dynamic interest rate. Usually offered with a very low “teaser” rate, ARMs eventually reach a point where their rates are based on one or more interest rate indexes. These indexes include the rates found for Treasury bills, certificates of deposits, banks’ savings indexes and many more, but are selected at the lender’s discretion.

Because ARM rates are permitted to rise and fall with the index they are tied to, homebuyers’ experiences change in their monthly payments, and sometimes dramatic changes at that. If rates are on the rise, it is not uncommon for an ARM’s holder to see his or her rates rise by 4 or 5 percent over the course of a few years. The flip to this is if rates fall, the ARM rates fall with them, leaving the mortgage holder with lower monthly payments.

Fixed-Rate Mortgages

Having a fixed rate means the home mortgage carries a static interest rate. This means when a buyer purchases a home using a fixed-rate mortgage, his or her interest rate is locked in at the rate the homebuyer and lender agree upon at the date of the loan’s creation. Barring any future refinance, the homebuyer can expect to pay that agreed upon interest rate on the home mortgage for the entirety of the loan’s existence.

Which is the Right One?

For those planning on turning a home purchase into a permanent residence, where remaining for 20 or 30 years sounds like a reasonable approximation, a fixed-rate mortgage may be the best route. Booms and recessions will come and go, but rates will remain stagnant.

If a home is merely a short-term investment or a stepping stone to get elsewhere, then a mortgage  similar to a 5/1 ARM (meaning the ARM is fixed with the teaser rate for 5 years, then adjusts for the duration of the loan) may be a prudent choice.

Some live and die by fixed-rate mortgages, while others insist the market should determine one’s decision. Ultimately, there is no right choice. Prospective homebuyers should compare mortgage rates and determine what they qualify for and then consider their financial situation, the status and direction of the economy, the duration they intend to keep the house and how important a steady pay schedule is to them and their pocket book.