So you have decided to buy a new home. You may be asking yourself, what’s next? There are many issues to consider, not the least of which is deciding which type of mortgage works best for you. In the lending industry, there are two standard types of loans: fixed rate and adjustable -ate. Before you jump to a conclusion that one is better than the other, it is best to learn as much as you can about the advantages of each.
What Is A Fixed Rate Mortgage?
Just as the name states, a fixed rate mortgage is a mortgage with one consistent rate that does not deviate throughout the length of a loan. Fixed rate mortgages are usually 30-year terms, but can be as low as 10 and, rarely, as long as 40. Though the percentage of the loan will not change during the term, the monthly amount due may change if taxes or insurance rates fluctuate.
What Is An Adjustable-Rate Mortgage?
An adjustable-rate mortgage, commonly referred to as an ARM or a variable-rate mortgage, is a loan that varies sometimes from month-to-month or year-to-year. The fluctuations follow certain criteria that are determined by the lender, though most use the US Treasury Rate as their benchmark. While there are different types of ARMs, the most common is called a Hybrid ARM. The Hybrid ARM allows for a fixed interest rate for a specific number of years. This is followed by a change in interest rates that occurs once annually. Depending upon the benchmarks used by the lender, those rates could either go up or down.
Why Choose A Fixed Rate Mortgage?
You may want a fixed rate mortgage if you want to avoid the uncertainty that comes with an ARM. If your future salary earnings are uncertain, a sudden increase in payments might be a shock that you do not need and cannot afford. Likewise, if you plan on remaining in your home for the long term, a fixed rate may prove to be less costly over time. Considering that the average homeowner stays in his or her house for 13 years, your odds of moving soon after a purchase may be slim.
Fixed rate mortgages are the most popular despite the fact that they are initially more expensive than ARMs. Approximately 80 percent of mortgages held in the United States are fixed rate. This may also be due to the unfortunate and misleading idea that ARMs are risky ventures. It could also be due to the relative ease of refinancing a home mortgage to get a lower rate.
Why Choose An ARM?
An ARM might be your ideal choice if you want to save money on the initial interest. ARMs often offer a much lower rate to start than fixed rate mortgages. If you are newly starting in your career, you may prefer to purchase a smaller home with an ARM so you can take advantage of a smaller monthly bill as you get settled. This is particularly true if you expect to start a family, which may require an upgrade to a new home. Likewise, if you expect a career change or job move, you can still enjoy home ownership without the higher price tag that may come with a fixed rate loan.
Interestingly, if you are already well-established in your career, an ARM may be for you as well. Rising interest rates are unlikely to cause you any financial burden, while the chance of a lower interest rate may be attractive enough to make you consider choosing this route.
Another reason to choose an ARM is to secure a larger mortgage loan. Those lower monthly payments let you extend yourself a bit further. This is especially beneficial if you are able to take advantage of low home costs, and then flip your investment into earnings or an upgrade by selling a few years down the road.
Which Is The Best Choice For Second Homes?
Primary home ownership is quite different than owning a second or vacation home. Lenders use different criteria for second homes than they do for your primary residence. You must have a high credit rating, a healthy debt-to-income ratio, and at least 20 percent for the down payment. If you meet these qualifications, you can then decide whether to use a fixed rate or ARM to secure your second home.
A fixed rate mortgage could be the best choice due to the fact that most vacation homes are long-term investments. However, interest on vacation homes is generally more expensive than the interest on primary residences. This may cause you to gravitate to an ARM, which has an initial lower interest rate. Theoretically, you could also purchase a second home in a more ideal location with money saved from choosing an ARM. As with loans for your primary residence, choosing the type of loan for your vacation home depends largely on your own comfort level.