Mortgages Vary By Two Rate Options

The journey to buying your first home often starts with researching different types of mortgages. These loans can help you realize your dream of homeownership, but they involve different paths.

You need to understand the mortgages types and the differences between fixed-rate mortgages and adjustable-rate mortgages (ARMs). Several mortgages fall into these two categories, but understanding the differences between these two options is the first step to effectively comparing mortgage opportunities.

Fixed-Rate Mortgages

Fixed-rate mortgages are home loans without changing interest rates over the life of the loan. If you are approved for a fixed-rate mortgage, you will have the same interest rate and payment for the entire mortgage. This type of mortgage offers several benefits, including predictable monthly mortgage payments and protection against interest rate increases. Even if the Federal Reserve adjusts interest rates after you secure your mortgage, the lender can't change the interest rate on your loan.

Borrowers should also understand the potential downsides of fixed-rate mortgages. Your interest rate might be higher than the initial rates offered by ARMs. If interest rates decrease after you get your mortgage, your interest rate will not be adjusted down, which means you would need to refinance your mortgage to secure a lower rate of interest. If interest rates drop after you get a fixed-rate mortgage, you will still pay higher interest costs over the life of your mortgage.

Adjustable-Rate Mortgages

An adjustable-rate mortgage (ARM) is a home loan with an interest rate that can be adjusted periodically. ARMs generally have a fixed initial term when payments and interest remain the same. The initial fixed term can range from as little as six months up to 10 years, but most ARMs have initial fixed periods of three, five, or 10 years.

Your interest rate will be adjusted periodically to match the prevailing rate of interest after the fixed period is over. How frequently your lender can adjust your interest rate will depend on the terms of your mortgage. This adjustable-rate period will continue until the end of your mortgage and can make your mortgage payments unpredictable.

ARMs have caps that limit how much they can be adjusted. These caps might include the following:

• Cap on the initial increase - This cap restricts how much your lender can adjust your rate the first time after the fixed period ends.
• Cap on periodic adjustments - This cap limits the amount your interest rate can be adjusted each time an adjustment is scheduled following the initial adjustment.
• Lifetime cap - This cap limits how much your interest rate can be adjusted over the life of your mortgage.

For example, if your mortgage is a 5/1 ARM, this means your initial fixed period will be for five years, followed by periodic adjustments annually. If the interest rate cap structure is 5/2/5, this means that the lender can adjust your rate up to a maximum of 5 percent above or below your initial interest rate. During periodic adjustments, the maximum would be 2 percent, and the lifetime cap means that the maximum your rate could be adjusted during the life of your loan is 5 percent.

If your initial rate is 3.2 percent for the first five years, but interest rates are higher once it is over, your lender could adjust your rate upward but couldn't increase it higher than a maximum of 5 percent because of the initial and lifetime caps. Lenders can also adjust interest rates down if the prevailing interest rates have dropped during the adjustment periods. This path makes it important for prospective buyers to determine if they can afford the potential interest rate caps when shopping for a mortgage.

Adjustable-rate mortgages offer the following potential benefits:

• Lower initial rate of interest vs. fixed-rate mortgages
• Might be a better option if you plan to move within a few years because of savings on interest costs
• Potential interest savings over the life of your mortgage if interest rates fall
• Won't need to refinance to secure a lower interest rate if interest rates drop after you get your mortgage

You should also be aware of the following potential disadvantages of an ARM:

• Unpredictable payments after the fixed period ends
• Could pay significantly more in interest over the life of the loan
• Might not be the best choice if you plan to remain in the home for years

Fixed-Rate Mortgages vs Adjustable-Rate Mortgages

To help you understand whether to choose a fixed-rate mortgage or an adjustable-rate mortgage, you need to think about both types in terms of your financial situation, your long-term plans, and the state of the housing market. You can refer to the table below to understand how these two mortgage products compare.

Fixed-Rate Mortgage Adjustable-Rate Mortgage Interest - Remains the same throughout the life of the loan Interest - Initial interest rate might be lower than a fixed-rate mortgage but can be adjusted periodically up to the lifetime cap Payment -Remains the same throughout the life of the mortgage Payment - Remains the same during the initial period but can change with each periodic adjustment up or down Length of intended homeownership - If you intend to remain in your home for years, you could have higher interest costs over the life of your loan Length of intended homeownership - If you plan to move within the initial fixed period, an ARM could save you money on payments and interest Adjustability - The interest rate of a fixed-rate mortgage can't be adjusted, so the payments will remain the same even if interest rates increase Adjustability - Following the fixed period, the interest rate can be adjusted according to the defined period in your loan, which could make your payments unpredictable and volatile Current interest rate environment - Fixed-rate might not be the best option if the current rates are high but are likely to drop within the next few years Current interest rate environment - ARM might be a better option when the current interest rates are higher but are likely to drop within the next few years

How to Choose the Right Mortgage

Choosing the right mortgage involves evaluating your financial goals and situation. If you are searching for a starter home, you might consider an ARM to take advantage of the lower initial interest rates. Another instance in which an ARM might be a better choice is when the prevailing interest rates for mortgages are high but are expected to fall within the next few years. In that situation, getting a fixed-rate mortgage might mean being stuck with a higher interest rate and higher costs over the life of the loan or having to refinance your mortgage.

A fixed-rate mortgage might be the best choice if you want predictable payments, can't afford the lifetime capped interest amount on an ARM, have excellent credit, and can qualify for the lowest interest rates based on your creditworthiness. A fixed-rate mortgage might also be a better choice if you plan to remain in the home during the entire life of your mortgage.

Consulting experienced mortgage professionals can help you determine which option might be best for you. Once you have chosen the type of mortgage, you can then shop around to find an offer with the best rate and terms to meet your needs and down payment size.

Make the Right Choice with La Cap

Understanding the key benefits and disadvantages of fixed-rate mortgages and adjustable-rate mortgages is the first step to take when you are planning to buy a home. You'll need to carefully consider your financial priorities, goals, and situation and choose the type of mortgage that offers the most benefit to you. Once you have determined whether a fixed-rate or adjustable-rate mortgage makes more sense for you, you'll then need to choose the right mortgage program within your selected category. To learn more and to apply for a mortgage that best meets your needs, contact La Capitol Federal Credit Union today.