How to Choose Between a Fixed-Rate Mortgage and an Adjustable-Rate Mortgage

Now that interest rates on fixed rate home loans are beginning to increase, more and more homebuyers are showing renewed interest in adjustable rate mortgages. ARMs are riskier, but the lower rates in the initial years are tempting more borrowers to commit to this kind of mortgage.

Can't decide between fixed-rate mortgages and ARMs? We have got all the information you need to make an informed decision.

Question: I don't know if I should choose a fixed-rate home loan or an ARM. How can I find out which one is the best for me?

Answer: It depends on your unique situation. Ask yourself how long you intend to live in the house.

ARM is a smart choice for buyers who intend to move out in the next few years. These mortgages have lower interest rates during the initial period which can last up to ten years. During this period, your monthly payment will not change. The loan will reset after the initial period and then the monthly payments can rise significantly. It is hard to predict what the rates will be like when the fixed period ends. It is this unpredictability that makes ARMs riskier.

On the bright side, this kind of mortgage also offers substantial benefits for a borrower who intends to sell the home or who is going to inherit a huge sum before the initial period expires.

Because the initial monthly payments on an ARM are significantly lower than the monthly payments on a fixed-rate home loan, you will be able to qualify for a bigger loan. In addition, lower monthly payments will allow you to save more money.

The biggest downside is that borrowers who do not sell their home before the expiry of the initial period will be in for a totally unpleasant surprise when the loan adjusts. That is why it is important for buyers not to overextend themselves. If you choose an ARM, you will be able to qualify for a bigger loan, but that doesn't necessarily mean that you should have it.

By contrast, fixed-rate home loans are the best option for those borrowers who intend to live in the house for a long period. Irrespective of what happens to mortgage rates or the economy, your monthly payments will remain the same throughout the life of your loan. This kind of mortgage is ideal for people who have a fixed monthly income. People who do not have a high risk appetite, too, should opt for a fixed-rate home loan.

Playing it safe has its own downsides. If the rates fall to even lower levels in the future, you will not be able to take advantage of them. You will have to be content with the interest rate which was in force on the day you signed up for the loan.

In this case, refinancing your mortgage will be the only option you have to get a lower rate. Unfortunately, this can be a long and arduous process.

Another negative with fixed rate home loans is that during the initial years, you will be paying much more interest than principal.

So here is the verdict: If you intend to sell the home after a few years, an adjustable mortgage should be your choice.  Just make sure that you sell the property before the rates adjust. However, if you intend to live in the house for the rest of your life, a fixed-rate home loan is the most appropriate option.