Adjustable-Rate vs. Fixed-Rate Mortgage Loans
Adjustable-rate mortgages vs. fixed-rate mortgages. It's one of the most important decisions a home buyer can make. In order to make the right choice, you need to understand how each of these loans work -- in addition to their pros and cons. And that's exactly what we will discuss in this article.
Let's start by examining the key differences between these financing options. This will make the fixed-versus-adjustable decision much easier for you.
Fixed vs. adjustable-rate mortgages, at a glance:
Choosing Between Fixed vs. Adjustable
So how do you decide which type of loan is right for you? In order to get past the fixed-rate vs. adjustable mortgage dilemma, you need to think about your long-term plans. This is the key to choosing the right type of loan. Consider the two scenarios below:
For a Longer Stay...
Do you plan to stay in the home for many years? If so, you're better off with a fixed mortgage that carries the same interest rate over the life of the loan. If you want to refinance later on, in order to secure a lower rate, you'll still have that option. But if you start off with an ARM loan to get a lower interest rate during the initial phase, you face the uncertainty of the adjustment period.
To get a better understanding of the adjustable-rate vs. fixed-rate mortgage issue, we can simply look back at what happened during the housing crisis. Many home buyers chose the adjustable mortgage with the intention of refinancing before the first adjustment period. Their logic was simple, though somewhat flawed: "I'll use an ARM loan to lower my monthly payments for the first five years, and then I'll refinance into a fixed-rate before the loan start adjusting."
Here's the problem with this strategy. There is no guarantee you'll be able to refinance the loan later on. If your home values drop too much, or your credit score takes a hit for some reason, refinancing might be impossible.
This is something that got a lot of homeowners into trouble over the last few years (contributing to the mortgage crisis of 2008 - 2009). People started out with adjustable mortgages, for the reasons mentioned above. But they were unable to refi out of the loans. Many homeowners saw their monthly payments increase significantly, even doubling in some cases. The rest is history. We saw record-breaking numbers of mortgage defaults and foreclosures, followed by a full-blown recession.
Beware of any mortgage broker or lender who recommends this strategy. They don't bear any of the risk -- you do. They are not concerned with your long-term financial success. They can sell your mortgage into the secondary market to get it off their books. So if you were to default later on, because the payments grew too large, it wouldn't be their problem. In other words, your lender is not your financial advisor. You need to make your own decisions, based on research, planning and common sense. Keep this in mind as you ponder the adjustable-rate versus fixed-rate question. Make the smart choice, based on your long-term plans.
For a Shorter Stay...
There are situations where you can use the ARM loan to save money, while avoiding the risk and uncertainty of the adjustment phase. Here's a good example: A military family moves to a new city and buys a home. It's only a three-year tour, after which they'll be moving again. These folks could use a 3/1 or 5/1 ARM loan to secure a lower interest rate. The rate would remain fixed for three to five years, depending on the terms of the loan. So they would end up selling the house before the first adjustment period (or shortly thereafter). The only risk in this situation would be a serious drop in property value, which could make it harder to sell the home. Aside from that, it's a perfectly sensible strategy for financing the home.
If you'd like to learn more about using a fixed vs. adjustable-rate mortgage loan, be sure to use the search tool at the top of this website. You'll find dozens more articles on this.