Which is better — a fixed-rate mortgage or an adjustable-rate mortgage? It’s a common question among home buyers and refinancing households in IL.
The answer? It depends.
Fixed-rate mortgages give the certainty of a known, unchanging principal + interest payment for the life of the loan. This can help you with budget-setting and financial planning. Some homeowners say fixed-rate loans they offer “peace of mind”.
Adjustable-rate mortgages do not.
After a pre-determined, introductory number of years, the initial interest rate on the note — sometimes called a “teaser rate” — moves up or down, depending on the existing market conditions. It then adjust again every 6 or 12 months thereafter until the loan is paid in full.
ARMs can adjust higher or lower so they are necessarily unpredictable long-term. However, if you can be comfortable with uncertainty like that, you’re often rewarded with a very low initial interest rate — much lower than a comparable fixed rate loan, anyway.
Freddie Mac’s weekly mortgage survey highlights this point.
The interest rate gap between fixed-rate mortgages and adjustable-rate mortgages is growing. It peaked 2 weeks ago, but remains huge at 1.16 percentage points.
On a $200,000 home loan, this 1.16 FRM/ARM spread yields a monthly principal + interest payment difference of $136, or $8,160 over 5 years, the typical initial teaser rate period.
Savings like that can be compelling and may push you toward an adjustable rate loan.
You might also consider a 5-year ARM over a fixed-rate loan if any of these scenarios apply:
- You’re buying a new home with the intent to sell it within 5 years
- You’re currently financed with a 30-year fixed mortgage and have plans to sell the home within 5 years
- You’re interested in low payments, and are comfortable with longer-term payment uncertainty
Furthermore, homeowners whose existing ARMs are due for adjustment might want to refinance into a brand new ARM, if only to push the teaser rate period farther into the future.
Before choosing ARM over fixed, though, make sure you speak with your loan officer about how adjustable rate mortgages work, and their near- and long-term risks. The payment savings may be tempting, but with an ARM, the payments are never permanent.