When you shop for a new home, it’s important to choose the mortgage loan program that best fits your situation. The two most common types of mortgage programs are known as conventional mortgages. Here is an overview of adjustable and fixed-rate mortgages to help you better understand your options.
Adjustable Rate Mortgage Basics
An adjustable-rate mortgage (ARM) is a loan with a term that offers a short period of fixed interest, so your monthly payments will be the same for that amount of time. When that period of fixed interest ends, the payment will adjust with whatever index the loan is based on. An ARM may have a period of fixed interest that is three, five or seven years. For example, if you have a 5/1 ARM (the first number stands for the number of years in the initial fixed period, and the second indicates how often the new rate will adjust), the initial interest rate will be the same for the first five years, and then will adjust annually for the remaining term.
The most common reason homebuyers choose an ARM over a fixed-rate mortgage is because of the comparatively low initial interest rate and the affordable monthly payment. However, since the interest rate is adjustable, the payments will go up or down based upon an index after the fixed-rate period.
- Features lower rates and payments early on in the loan term, which can help you save and invest more money.
- Allows you to take advantage of falling rates without refinancing and having to pay additional closing costs and fees.
- Offers a less expensive solution if you plan on moving from your home within three to five years.
- Rates and payments can rise significantly over the life of the loan. For example, a 6% ARM can end up at 11% in just three years if rates rise sharply.
- Difficult to budget as future payments are unknown until the fixed rate term of the loan has ended.
- On certain ARMs, called negative amortization loans, you can end up owing more money than you did at closing. That’s because the payments on these loans are set so low (to make the loans even more affordable) that they cover only part of the interest due. The remainder gets rolled into the principal balance.
Fixed Rate Mortgage Basics
A fixed-rate mortgage is a loan type where the monthly principal and interest payments remain the same throughout the life of the loan. The most common mortgage terms are 15 and 30 years. With a 30-year fixed-rate mortgage, your monthly payments are lower than they would be on a 15-year fixed rate, but the 15-year loan allows you to repay your loan twice as fast and save more than half the total interest costs.
Fixed-rate mortgages come with an interest rate that remains constant over the life of the loan. The interest rate is usually initially a bit higher than for other types of mortgages. However, because the interest rate and monthly payment are fixed, they provide a stability that is appealing to many buyers.
- Rates and payments remain constant. There won’t be any surprises even if mortgage rates increase drastically.
- Stability makes budgeting easier, and you can manage your money with more certainty. Because the payment due each month won’t change over the life of the loan, you will know what to expect.
- To take advantage of falling rates, you would have to refinance, which can be pricey.
- Monthly payments may be too expensive to afford, especially in high-rate environments.
If you plan on being in the home for longer than five years or if you prefer the consistency of knowing what payments to expect, a fixed-rate mortgage could be the right mortgage choice for you.
About UW Credit Union
This information is provided to you courtesy of UW Credit Union, based in Madison, WI. UW Credit Union is a leading provider of home loans in Dane County and throughout Wisconsin.
For more information about the home loan process, please contact a UW Credit Union Home Loan Specialist at 800.533.6773, ext. 2810, or vist UWCU.org.