Which Saves You More: an ARM loan or a Fixed-Rate Mortgage?

While many homeowners stick to a standard 30-year or 15-year fixed rate mortgage, the simple fact is that there are many different kinds of mortgages.  When you sit down with your loan officer, you’ll hear about mortgages with balloon payments, FHA loans, interest-only mortgages, piggyback mortgages, and many others.  With so many different options available, it can be quite difficult to compare the different types, and find the one most cost-efficient in your situation. 

As with any financial decision, there are a number of things you’ll want to consider before selecting a specific loan. Your primary choices will be the fixed rate mortgage and adjustable rate mortgages, or ARMs. Each loan has attractive features, but here are some of the ins and outs to make sure you choose the correct loan for your home.

Rates – As you can tell from its name, a fixed rate mortgage offers a set rate of interest that is constant throughout the term of your loan, which makes setting a budget much easier for homeowners. With interest rates currently at historic lows, fixed rate mortgages are an appealing option, as you’ll be locking in a low rate for the length of the loan. To control the total cost of the house, you can select the terms of the loan, typically either a 15 year mortgage or a 30 year mortgage.

With an adjustable rate loan, the interest rate will vary over time. ARMs are attractive initially because they feature low payments and interest rates early on in the mortgage term, usually for a set adjustment period before schedule changes will take place. Adjustable rate mortgages are riskier than fixed rate mortgages, since your payments could change significantly. You are rewarded for that risk with rates that are initially much lower than a fixed rate mortgage.

ARMs can be complicated –  With a fixed rate mortgage, you know what you are getting all the time – it never changes. Before you select an adjustable rate mortgage, make sure you understand key terms like the adjustment period, adjustment frequency, adjustment indexes and the loan ceiling. The adjustment frequency – typically monthly, yearly or in multiple years – is one of the most important aspects, as it will determine the volatility of the interest rate.

Length of time you plan on staying in your home – If you plan on staying in your home just a few years and then selling it, ARMs can be a better solution than fixed rate mortgages.  With an ARM, your interest rate is fixed for a certain initial period, such as 3, 5, or 7 years.  After the fixed-rate period, the rate typically adjusts once annually for the rest of the life of the loan.  If this rate is lower than a fixed rate mortgage, and you are confident you can sell your home in the near future, then you’ve found yourself a good deal. 

On the other hand, if you can’t sell your home or get access to another mortgage, you will be locked into a mortgage that may have an increasingly expensive interest rate.  In that case, a fixed rate mortgage will cost you less over the total life of the loan.

Which is right for you?

The answer really is, “it all depends.”  If you are looking for low payments on a home you plan on selling within a few years, an ARM can be a great choice. If interest rates are climbing, or if you want a more stable payment schedule, a fixed rate mortgage is probably the right fit for your finances. No matter which loan you are leaning towards, your best bet is to think it through very carefully with the help of a loan officer and choose the loan that allows you to meet your financial goals.