Fixed Rate vs Adjustable Rate Mortgage (ARM)
Whether you are buying a new home or planning to refinance, you may be asking the question – ARM vs Fixed mortgage rate – which one is better? When you are trying to make a decision on whether to take an Adjustable Rate Mortgage or a Fixed, you should consider two factors:
- How long you plan to stay in the property?
- What is the difference in the interest rate between an ARM & a Fixed?
Let me elaborate this:
Rates on ARMs are usually lower than fixed rate loans. But the rates are fixed only for 5 or 7 years. So if you do plan to live in your house for more than that period, you may risk your mortgage adjusting into a very high rate prevalent at that time. However, if the current interest rate difference is substantial you may still want to take the risk.
This chart assumes a $400,000 loan, the fixed rate is 5.25%, while for a 5 year ARM the start rate is 4.5%. In 5 years you would have saved $10,920 in monthly payments on an ARM loan. Assume, the rate on the ARM adjusts to 6% after that and you pay the same rate for next 25 years. In that case, if you kept the loan for 30 years – on a Fixed rate, you would have saved $31,080 in mortgage payments.
As you can see in the example if you were to keep the house for 5 years it absolutely made sense to get an ARM. However if you kept the loan for 30 years the fixed rate option made more sense. So make sure you factor both aspects mentioned at the beginning of the post before deciding on what kind of loan program works better for you.
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