Tips on the Loan Process

The Deciding Factors Between Adjustable vs. Fixed


As part of our continuing service to you, here are some more tips that may help when you’re looking to purchase a new house or refinance your home loan. The article that follows is from


Types of Mortgages – Adjustable vs. Fixed

Which is the better mortgage option for you: fixed or adjustable?


The low initial cost of adjustable-rate mortgages (ARMs) can be very tempting, yet they carry a great deal of uncertainty. Fixed-rate mortgages (FRMs) offer rate and payment security, but they may be more expensive.


Here are some pros and cons of ARMs and FRMs.

ARM Advantages

  • Lower rates and payments early on in the loan term. Because lenders can use the lower payment when qualifying you, you can purchase larger homes than you otherwise could buy.
  • Take advantage of falling rates without refinancing. Instead of having to pay a whole new set of closing costs and fees, ARM borrowers just sit back and watch their rates drop.
  • Save and invest more money. Someone who has a payment that’s $100 less with an ARM than with a FRM for a couple of years can save that money and earn more from it in a higher-yielding investment.
  • It’s a cheap alternative for borrowers who don’t plan on living in one place for very long.

ARM Disadvantages

  • Rates and payments can rise significantly over the life of the loan. A 6 percent ARM can end up at 11 percent in just three years if rates rise.
  • Your initial low rate will adjust to a level higher than the going fixed-rate level in almost every case, even if rates in the economy as a whole don’t change. This is due to the fact that ARMs have initial fixed rates that are set artificially low.
  • The first adjustment can be a doozy because some annual caps don’t apply to the initial change. Someone with an annual cap of 2 percent and a lifetime cap of 6 percent could theoretically see the rate shoot from 6 percent to 12 percent 12 months after closing if rates in the overall economy skyrocket.
  • ARMs are difficult to understand. Lenders have much more flexibility when determining margins, caps, adjustment indexes, etc., so unsophisticated borrowers can easily get confused or trapped by shady mortgage companies.
  • On certain ARMs, called negative amortization loans, you can end up owing more money than you did at closing because payments on these loans are set so low (to make the loans even more affordable), that they only cover part of the interest due. Any additional amount due gets rolled into the principal balance.

Fixed Rate Mortgage advantages:

  • Rates and payments remain constant. There won’t be any surprises even if inflation surges out of control and mortgage rates reach toward 20 percent.
  • Stability makes budgeting easier. You can manage your money with more certainty because your housing outlay doesn’t change.

When considering fixed-rate versus adjustable mortgages, ask yourself the following questions:

1. How long do you plan on staying in the home?
If you’re only going to be living in the house a few years, it makes sense to take the lower-rate ARM, especially if you can get a reasonably priced 3/1 or 5/1 ARM. Your payment and rate will be low and you can build up more savings for a bigger home down the road. Plus, you’ll never be exposed to huge rate adjustments because you’ll be moving out before the adjustable rate period begins.

2. How frequently does the ARM adjust, and when is the adjustment made?
After the initial fixed period, most ARMs adjust every year on the anniversary of the mortgage. The new rate is actually set about 45 days before the anniversary, based on the specified index, but some adjust as frequently as every month. If that’s too much volatility for you, go with a FRM.

3. What’s the interest rate environment like?
When rates are relatively high, ARMs make sense because their lower initial rates allow borrowers to reap the benefits of homeownership. The chances are fairly good that rates will fall down the road, too, meaning you’ll have a decent chance of getting lower payments even if you don’t refinance. However, when rates are relatively low, FRMs make more sense. After all, 5 percent is a great rate to borrow money at for 30 years!

4. Could you still afford your monthly payment if interest rates rise significantly?
On a $150,000, 1-year adjustable-rate mortgage with 2/6 caps, your 5.75 percent ARM could end up at 11.75 percent.

Now, let’s compare a worst-case scenario to a fixed-rate mortgage:

ARM Chart

In the above case, the fixed-rate mortgage costs less than the worst-case ARM scenario. Expert’s say when fixed mortgage rates are low they tend to be a better deal than an ARM, even if you only plan to stay in the house for a few years.


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