Fixed Rate vs ARM: Consumer’s Guide

Fixed Rate vs ARM: Consumer’s Guide

Lenders create mortgages with two major types of interest rates: fixed and adjustable. As the name suggests, a fixed rate mortgage has an interest rate that does not change. The buyer locks it in at the beginning of the mortgage and pays that same interest rate for as long as he keeps the mortgage. In contrast, most adjustable rate mortgages are set up with a fixed rate for the first five years, plus the potential for an annual adjustment every year after that for the duration of the mortgage. This is often called a 5/1 ARM. Each type of mortgage has its advantages, but most buyers come out with a clear choice in favor of one type or the other. Fixed rate vs ARM, consumer’s guide:

Advantages of Fixed Rate Mortgages

• A fixed rate mortgage has a guaranteed interest rate that provides peace of mind in the midst of a changing financial world.
• A fixed rate mortgage has the same monthly payment amount during the entire mortgage, which helps borrowers budget accordingly.
• When market interest rates are low, locking in a fixed rate for several decades can save a lot of money on interest charges.

Advantages of Adjustable Rate Mortgages

• The starting interest rate on an ARM is almost always lower than the fixed rate the same buyer would qualify for.
• Initial monthly payments on an ARM are lower, which helps buyers with a low income qualify for a larger mortgage.
• An ARM is ideal for buyers who plan to move or refinance during the first five years while the rate is still low.
• When market interest rates are high at the beginning of the loan term, the adjustable rate is likely to remain below the fixed rate for much of the repayment term.

Making the Choice Between a Fixed Rate and ARM

Borrowers need to consider the broader market when evaluating which type of mortgage is better. For example, in April 2013, Bankrate.com reported an interest rate of 3.61% for the average 30-year fixed rate mortgage and a rate of 2.66% for the first five years of an ARM. Because the fixed rate of 3.61% is historically low, this is a superb rate to lock in for the next 30 years. On the other hand, the adjustable rate of 2.66% is almost definitely going to increase after the first five years. Because the ARM is likely to cost a lot more in the long run, most people buying in 2013 are opting for a fixed rate.