Here I am sitting in front of my computer on a very hot afternoon contemplating on how to answer the controversial topic of "Fixed Rate Loans versus ARM Loans: Which is Better?". Interestingly, I think the questions should be “to fix the mortgage or not to fix”, that is the question!
The only person that can answer this question is you, the borrower/home buyer/home owner. Whether to choose a fixed rate or an adjustable rate mortgage depends on what is the financial goal(s) is and the true purpose of owning the home. However, it is important for you to find out what makes these two loan programs so different. You (the borrower/home buyer/home owner) will know which loan program is best for you(whether it is the fixed rate mortgage or an adjustable rate mortgage (ARM)) once you figure out what your goal(s) and purpose is along with knowledge of what makes them different.
It is important to know what these loan programs are. You can not decide without know what they are. It is like trying to decide if you want lemon or lime for your grill salmon. How would you know which to choose if you don't know what makes them difference from one another? Lime has more of a tart taste, and lemon has a more citrus taste. If you are in the mood for citrus salmon, you would choose lemon.
First let's define what a “fix rate mortgage” is. Definition: A fixed rate mortgage is a mortgage where your interest rate and your monthly mortgage payments do not change. There are two type of fix rate mortgage s: 30 year fixed rate mortgage (30 year fix) and a 15 year fixed rate mortgage (15 year fix). For example, a 30 year fixed rate mortgage means that the interest rate on the loan is fixed for 30 years, the monthly payment does not change, and the loan is due in 30 years.
On the other hand, the “adjustable rate mortgage (ARM)” is the opposite. Definition: An adjustable rate mortgage (ARM) is a mortgage where your interest rate and monthly payment will vary monthly or over time depending on the terms of the loan. There are many types of ARMs--too many for me to cover in one post unless I like being the “lone rider” with no reader. However, all ARMs have the same basic features. The primary features are the:
- Index : The interest rate goes up and down according to a nationally published index. Different adjustable rate mortgages are based on different indexes, and the index is specified before settlement of the loan. For example some of the indexes are:
- The 11th District Cost of Funds Index (COFI)
- United States Treasury Bills (T-bills)
- London Interbank Offering Rate Index (LIBOR)
- Margin: Is the Bank/Lender’s profit on the loan. Your interest rate is the sum of the index plus the margin: index + margin = interest rate. The Bank/Lender sets the margin before settlement of your loan, and the margin does not change for the life of the loan
- Adjustment Frequency: is how often the interest rate changes (gets reset). The day the interest rate changes is sometimes called the reset date.
- Initial Interest Rate: is the interest rate you pay until the first reset date.
- Interest Rate Cap: is the limit for how high your interest rate and monthly payment can increase.
- Convertibility: specifies if you can convert the loan to a fixed rate or not. If an adjustable rate mortgage is convertible, you can convert it to a fixed rate mortgage without refinancing. However, the terms will vary by each Bank/Lender.
What are the advantages and disadvantages of having a fixed rate mortgage?
Advantages:
- Interest rate does not change during the term of the loan.
- Set monthly payment.
- Interest rate is not affected if rates are rising.
Disadvantages:
- Higher interest rate and monthly mortgage payment.
- Interest rate stays the same even if interest rate are falling.
What are the advantages and disadvantages of having an ARM?
Advantages:
- Lower interest rate.
- Lower monthly mortgage payment.
- More cash left over.
- Take advantage of falling interest rate without refinancing.
- Lots of options. There are fixed interest rate ARM that are fixed for a short period of time such as 3 years ARM, 5 years ARM, 7 years ARM, or 10 years ARM.
Disadvantages:
- Interest rate is not fixed for the entire term of the loan.
- Too many different types of ARM programs--some can be very complex to understand.
- Some ARMs can eat your equity such as the Option ARM programs.
What kind of financial goal(s) will be fitted for a fixed rate mortgage?
Someone who has the following financial goal(s) will most likely be best off with a fixed rate mortgage:
- Looking for financial stability and security.
- On a tight budget.
- On fixed income such as Social Security, retirement money, and so on.
- Want no mortgage debts by the time they retire.
- Know for sure they will not refinance within 30 years.
What kind of purpose for owning a home will best suite for owning a fixed rate mortgage?
Anyone who has the following intent:
- Plan to retire in the home.
- Want to die in the home.
- Going to retire within 10 years.
- Know for sure they will own the home for more than 30 years.
What kind of financial goal(s) will be best suited for an adjustable rate mortgage (ARM)?
- Want to maximize monthly cash flow.
- Want lower monthly mortgage payment.
- To have more control over fluctuating monthly income like most self employed people.
- Want extra cash to make other investments.
- Know they will most likely refinance within 30 years.
What kind of purpose for owning a home will best suite for owning an adjustable rate mortgage (ARM)?
- Does not plan to live in the home for 30 years.
- Does not plan to retire in the home.
- Does not plan to keep the home forever.
- Will sell the home within 10 years.
- Will move within 10 years.
Thus, it is not about whether the fixed rate mortgage is better or worse than an ARM. It is about what are you, the borrower/home buyer/home owner, wants to accomplish by owning a home. Through understanding what is your financial goal(s) and purpose of owning a home, you will be able to figure out “to fix the mortgage or not to fix”, that is the actual question you need to ask yourself!
Good Nite Everyone!
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