Interest rate is one of the most important aspects of choosing a loan product. Your interest rate is largely determined by your credit score, however, there are two options that affect your interest rate and give you more of a choice. Those two options are a fixed rate mortgage and an adjustable rate mortgage and both have their benefits.
A fixed rate mortgage is one on which your interest rate and payment remain the same during entire life of the loan. This option may be a good choice for you if rates are currently low and you are planning to stay in your home for a long time. Most fixed rate loans also allow you to pay off the balance of the loan early without incurring any penalty fees. In addition, this loan allows you to add any amount to your fixed monthly payment in an effort to pay off the loan quicker. Most of the time, this loan is utilized for a 15 or 30 year term, however, it is also offered in 10 or 20 year terms. The length of your term will directly impact your monthly payment amount. The shorter your term, the larger your monthly payment; therefore the 30 year term would offer the lowest monthly payment.
An adjustable rate mortgage, or ARM, is a loan on which your interest rate changes annually. The changes in rate are based on a market index and can increase or decrease depending on what current market trends are. Though this loan’s interest rates adjust annually, they do not always start adjusting the first year. Unlike how the fixed rate mortgage’s terms determine the life of the loan, terms on an ARM determine which year the interest rate will begin adjusting. For example, a 5/1 ARM will have a fixed rate for five years, after which it will adjust annually. To prevent too steep of a rate increase, ARMs (when originated) have “caps,” which set a limit to how much the interest rate can raise annually and for the life of the loan. For example, an ARM that has a 2% annual cap and a 6% lifetime cap, cannot raise more than 2% annually and can never go over 6%. This option is great for buyers who are looking for a slightly lower rate during the first few years of their loan, but know that their income will be raising steadily in the future to compensate for any adjustments.
Both the fixed rate mortgage and the ARM have their place determined by the borrower’s situation. However, either one offers its own set of benefits for any homebuyer. The best way to determine which rate option is best for you is to call or make an appointment with one of our mortgage bankers. They can easily analyze your finances, current and future situation and determine which option will be the most beneficial for you.