Deciding Between a Fixed-Rate or Adjustable-Rate Mortgage Comes Down to Risk
That’s the bottom line, according to the Houston Chronicle.
Adjustable-rate mortgages have an initial interest rate that is often lower than a fixed-rate loan. But their fluctuating or variable interest rates are more complex. A formula that specifies the rate index determines the interest on an adjustable-rate mortgage.
For example, a particular adjustable-rate mortgage’s interest rate may be tied to the interest rate on one-year Treasury bills, plus 2.5 percent.
Because the mortgage rates are linked to interest rate movements in general, an adjustable mortgage’s interest rate, and your payment, will change over time.
Because you are accepting a greater element risk, adjustable-rate loans start at a lower interest rate than comparable fixed-rate mortgages.
A fixed-rate loan maintains a constant and level interest rate. The primary benefit of a fixed-rate mortgage is that you know with complete certainty what your payment will be. Because the mortgage lender is locking in your rate for the entire 15- or 30-year term, you generally will pay a premium in the form of a higher interest rate.
To answer the question of whether you should take out an adjustable-rate mortgage or a conventional, fixed-rate loan, weigh two important issues:
1. How long do you plan to stay? Because adjustable-rate mortgages start at a lower rate of interest, and should remain lower unless interest rates rise, you would save money on interest charges and have lower payments in the early years of your home mortgage loan with an adjustable.
Basically, other things equal, the less time you expect to hold on to a property, the more beneficial adjustable-rate mortgages will be for your situation.
2. How much risk can you accept? Because an adjustable-rate mortgage can increase if interest rates rise in general, ask yourself if you can handle these higher payments. Make sure that your budget will allow you to accept the highest possible payments allowed on your ARM.
If you can’t afford the higher payments or you can’t deal with the stress or risk of volatile payments, you’re better off sticking with a fixed-rate mortgage.
Sometimes, prospective home buyers are steered into an adjustable-rate loan because it allows them to stretch and buy a more expensive home. Be careful that you’ve taken the time before you close on a deal to fully understand what impact higher payments might have on your budget.