If you’re like many people financing a home in Aspen, there’s a chance you’re a bit overwhelmed with all your financing choices – and that’s okay. There are dozens of loan products to choose from, but most mortgages come in two main types: adjustable-rate (ARM) and fixed-rate. So should you choose an ARM or a fixed-rate mortgage? Here’s what you need to know.
Should You Choose an ARM or a Fixed-Rate Mortgage?
Adjustable-rate and fixed-rate mortgages both get you to the same goal: Home ownership. However, the way they get you there varies.
Adjustable-rate mortgages, or ARMs, start out with a set interest rate. The interest rate is often lower than what you’d get if you took out a fixed-rate mortgage. However, that interest rate changes (adjusts) after a certain amount of time. Usually, that introductory period lasts three, five, seven or even ten years.
When the interest rate adjusts, it does so based on market indexes. If the indexes go up, so does your payment; if they go down, your payment gets lower.
These types of mortgages do have pros:
- You get a lower initial rate
- You may be able to borrow more (which means buying a more expensive house) because your lender will use the lower monthly payment (thanks to the lower initial interest rate) when determining your eligibility for a loan
- Your rate may go down
ARMs also have cons:
- Your interest rate is unpredictable after your introductory term
- You won’t be allowed to pay off your loan for whatever number of years is specified in your agreement, so even if interest rates make a big jump, you’re stuck with the home (and you can’t refinance) without incurring a penalty
- Your interest rate and your house payments could go up significantly if the market index is high when your mortgage rate adjusts
With a fixed-rate mortgage, what you see is what you get. The interest rate stays the same over the lifetime of the loan, so if you finance a home purchase today at 3 percent interest, you’ll still be paying 3 percent interest when you pay off the home 30 years from now. Because the interest rate doesn’t change over the lifetime of the loan, a lot of people feel that fixed-rate mortgages are less risky than their adjustable-rate counterparts are.
Fixed-rate pros, for many people, include:
- The stability of knowing how much your mortgage payment will be over the lifetime of your loan
- Fixed costs allow you to budget more easily (your interest rate won’t change, so your payment won’t change unless your property taxes or homeowner’s insurance affects your balance due to the bank)
Some of the cons of fixed-rate mortgages are not being able to take advantage of lower interest rates without refinancing.
Related: 4 things you should know about mortgage loans
How Do You Choose Between Fixed-Rate and Adjustable Rate Mortgages?
There’s no one-size-fits-all answer for everyone. In fact, you may do better with one type of mortgage based on your financial situation right now. The two types of loans do the same thing – they get you into a home – but the process for each is different.
To make the right choice, ask yourself:
- How long do I plan to stay in the home? If you’re only living in the house for a short time (such as ten or fewer years), it may make sense to get an adjustable-rate mortgage to take advantage of the lower interest rate.
- How often does the ARM I’m interested in adjust? Most ARMs adjust every year on the same date – usually the mortgage’s anniversary – and the rate is determined by the index value about 45 days before that date. However, some ARMs adjust monthly.
- Could I still afford my mortgage payment if interest rates spike? An ARM can change significantly each year. In fact, it’s not unheard of for interest to go up by several points (imagine your 5 percent mortgage darting up to 11 percent).
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