Whether you're buying or refinancing a home, there are two basic types of mortgages to choose from: fixed-rate and adjustable-rate mortgages. Choosing the one that's right for your situation starts by understanding how they work.
As the name implies, the interest rate and monthly payment on this type of loan is fixed and remains the same for the life of the loan. You can choose the term that fits your situation and goals – the two most popular terms are 30-year and 15-year fixed loans. Fixed-rate mortgages are available for the complete range of loan options, including conforming, jumbo, FHA, and VA loans.
- You can count on predictable monthly payments of principal and interest for the life of the loan.
- You don't have to worry about rising interest rates.
- A fixed-rate loan is ideal for homeowners who plan to stay in their house for the long haul.
- The longer the term, the more overall interest you pay.
- The shorter the term, the higher your monthly payment will be.
Adjustable-rate mortgage (ARM)
The interest rate and monthly payment are fixed for the initial period of the loan – usually 3, 5, 7, or 10 years. At the end of the initial term, the interest rate and monthly payment adjust every year based on the movement of the market index it's tied to – the one-year Treasury bill index, the Cost of Funds Index (COFI), or the London Interbank Offered Rate Index (LIBOR). Adjustable-rate mortgages are available for the complete range of loan options, including conforming, jumbo, FHA, and VA loans.
- ARMs usually have a lower initial interest rate than fixed-rate mortgages.
- You can choose interest-only payments to maximize your cash flow.
- The interest rate has a cap after the initial term, so it can't ever go above a certain amount.
- An ARM is ideal if you plan to move or refinance within a few years.
- Your monthly payments may increase at the end of the initial term when the interest rate adjusts each year.
- If you choose interest-only payments, you won't be reducing your principal balance or building equity unless you make additional payments toward principal.
If you need help deciding between a fixed-rate and an adjustable-rate mortgage, talk to a professional – like your local Rabobanker. We're always here to help.
The information contained in this article is intended for general educational purposes only and is not to be construed as legal, tax, or financial advice. Please consult with your own legal, tax or financial advisor for guidance with your own particular circumstances.