An Adjustable Rate Mortgage’s interest rate changes after the fixed period expires. Typically, ARMs are 30-years loans, meaning that you’ll pay back the money you borrowed over the span of 30 years. At the beginning of the loan, you’ll start with a lower rate than average mortgage interest rates. The low rate will stay the same for a period of time, commonly 5, 7, or 10 years. After the fixed-rate period ends, your interest rate will adjust up or down based on an index.
A Fixed Rate Mortgage has the same interest rate throughout the life of the loan. With Fixed Rate Mortgages your monthly payment of principal and interest won’t change, though your overall payment can, depending on how your taxes and homeowners insurance fluctuate. A Fixed-Rate Mortgage loan is the most popular type of financing because it’s the most predictable.
The four main differences with Adjustable Rate Mortgages involve margins, rate caps, interest rates, and qualification.
Margins: Your ARM rate can never fall below a certain margin specified in your loan documentation. For example, if the margin specified is 3%, the margin is added to the current index number on the date your rate adjusts.
Rate Caps: ARM loans have rate caps that limit the amount your interest rate can rise or drop in a single period and over the lifetime of your loan. Your loan might not increase or decrease exactly along with the market if it hits its cap. So, an ARM with a 2/1/5 cap structure means that your loan can increase or fall 2% during your first adjustment and up to 1% with every periodic adjustment after that. Finally, your interest rate can’t increase or decrease more than 5% above or below the initial rate over the entire lifetime of your home loan.
Interest Rates: Interest rates for ARMs are lower than fixed-rate loans, at least for a few years. Lenders usually charge a higher interest rate for fixed-rate loans because they must predict interest changes over time. Because an ARM’s rate changes to fit the market, lenders can be more lenient with initial loan charges and give you a lower mortgage rate to begin with.
Qualification: When you apply for a mortgage, your lender looks at how much income your household brings in a month versus how much you spend each month. This is your debt-to-income (DTI) ratio, and it’s a major factor when you get a loan. If you have a high DTI ratio, you may have an easier time qualifying for an ARM than a fixed-rate mortgage.
Let’s just get right to it.
Adjustable Rate Mortgages may be good for paying more on your loan early on, living in your current home for a short amount of time, a high interest rate market, or if you’re getting close to retirement.
Fixed Rate Mortgages may be good for you if you’re buying your “forever home,” if you’re on a tight monthly budget, or if you’re in a low interest market.
The best way to determine which option is right for you is to dig into your specific scenario and situation. Reach out to us today to see how we can help you crunch the numbers and get a gameplan put together for that next home purchase!
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Signature Home Loans LLC does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Signature Home Loans NMLS 1007154, NMLS #210917 and 1618695. Equal housing lender.BACK TO LIST