One of the most important decisions you face in the loan process-and often the hardest-is whether to take out a fixed or adjustable rate mortgage.
What’s the difference between the two? In general terms, a fixed rate mortgage locks in at whatever prevailing interest rate is in effect at the time you arrange the loan. So no matter what happens to interest rates or inflation, your monthly principal and interest payment stays the same throughout the life of your loan. That stability is one reason why fixed rate mortgages are the most popular way to finance a home in America.
The mortgage payment for an adjustable rate mortgage, on the other hand, can change over time, since it continually “adjusts” to changing interest rates. That is good for lenders, because the rate keeps up with the prevailing rate. As a result, adjustable rate mortgages typically start at a lower interest rate than fixed mortgages do, and so your monthly principal and interest payment will be lower.
So, if the rate is lower, shouldn’t you just choose an adjustable rate? The answer is: it depends. Anyone taking out an adjustable rate mortgage should be able to answer yes to the following questions:
- Can I afford to make higher mortgage payments if rates go up?
- Do I believe that rates will remain the same or decline in the future?
- Do I plan on moving before 5-7 years?
The trade-off for the lower payments of adjustable rate mortgages is greater uncertainty in the amount of the payment. Deciding if the risks are worth it is a personal decision for every homeowner. Sometimes knowing your interest rate and monthly payment will not change can be an added peace of mind.