Choosing the right mortgage is the second most important decision you'll make when it comes to buying or refinancing a home. The first, and most important decision is choosing the RIGHT mortgage broker (but we wrote all about that this summer, read it here.) One of the primary considerations is whether to opt for a fixed-rate mortgage or an adjustable-rate mortgage (ARM). Both options have their advantages and disadvantages, and the choice you make will depend on your financial situation and long-term goals. For the first 20 years of my career, I was a staunch proponent of the fixed mortgage rate. You would rarely, if ever see my recommending an adjustable-rate mortgage. But, it's almost 2024, and the world looks a whole lot different today than it did 20 years ago so I just may be changing my tune. With interest rates being the highest they've been in years, locking yourself into a rate might not be the best idea. I've said it before, we can't know what the future holds, but if history is any indication, I suspect we'll likely see a decline in mortgage rates again. If that's the case, why lock yourself into a high mortgage rate? All that to say, there are many factors to consider when choosing a fixed versus adjustable mortgage. In this blog, we’ll explore the benefits of each type to help you make an informed decision.
Let's start with fixed-rate mortgages (the more common of the two). This is certainly the most traditional and straightforward option for many homeowners. Like I said, in my career, this is historically what I've always recommended. With a fixed-rate mortgage, your interest rate remains constant throughout the life of the loan. Because of this, there are some excellent benefits of choosing a fixed-rate mortgage:
- Predictable Payments: The primary advantage of a fixed-rate mortgage is predictability. Your monthly principal and interest payments stay the same for the entire loan term, typically 15, 20, or 30 years. This stability can help you budget effectively and plan for the long term.
- Protection Against Rate Increases: With a fixed-rate mortgage, you’re shielded from the risk of rising interest rates. If market interest rates increase, your mortgage interest rate remains unaffected, providing peace of mind and financial security. If these last few years have taught us anything, it's that we never know what the future holds. It goes without saying that the homeowners who locked in a 3% rate are feeling pretty comfortable in their fixed rate.
- Long-Term Planning: Fixed-rate mortgages are ideal for borrowers who plan to stay in their homes for an extended period. They offer financial stability, making it easier to plan for other long-term financial goals. If you know you're buying your "forever home", it can be beneficial to lock in a rate that you know you can afford and sustain as you grow other assets.
The benefits are pretty obvious, and these benefits are the exact reason that the majority of my clients have chosen fixed-rate mortgages, at my recommendation. But every pro has a con, so we must discuss the downsides to fixed-rate mortgages as well.
- They typically come with slightly higher initial interest rates compared to adjustable-rate mortgages, which can translate to higher monthly payments. For many people, a higher monthly payment simply isn't feasible. Buying a house is already an expensive endeavor, so why add financial stress?
- If market interest rates decrease after you secure your fixed-rate mortgage, you won’t benefit from lower rates without refinancing. This is the biggest con in my opinion and the reason why, for the first time in my career, I'm advising against fixed-rate mortgages (in certain cases.)
Now that you understand the pros and cons of a fixed-rate mortgage, let's discuss the benefits and downsides of an adjustable-rate mortgage (ARM)
First, what is it? An adjustable-rate mortgage offers a variable interest rate that adjusts periodically according to an index and a margin.
Here are some of the key characteristics and benefits of an ARM.
- Lower Initial Rates: ARMs usually start with a lower initial interest rate compared to fixed-rate mortgages. This can result in lower monthly payments initially, making them an attractive choice for those who want to save on interest in the short term. In 2023 (and likely 2024) despite higher interest rates, we have not seen a decrease in housing prices. For that reason alone, a lower monthly payment can be incredibly attractive.
- Rate Adjustments: The interest rate on an ARM can change over time, typically after an initial fixed-rate period, which can range from one month to several years. The frequency of rate adjustments depends on the specific ARM product.
If these benefits sound too good to be true, you might be wondering why everyone wouldn't opt for an adjustable rate. Well, as with the fixed-rate mortgage, there are some big downsides.
- Risk of Rate Increases: The downside of ARMs is the potential for interest rate increases in the future. Your monthly payments can go up significantly if market interest rates rise. This can make budgeting more challenging and may lead to financial strain. For the risk-adverse, it simply may not be worth bargaining on the market going down, when in all likelihood, mortgage rates could continue to rise. As the saying goes, "Better the devil you know, than the devil you don't."
The caveat: Fortunately, most ARMs come with rate caps and limits to protect borrowers. These caps restrict how much your interest rate can increase during each adjustment period and over the life of the loan.
In summary, the choice between a fixed-rate mortgage and an adjustable-rate mortgage is a significant decision in your home-buying journey. Fixed-rate mortgages offer stability and predictability, while adjustable-rate mortgages provide potential short-term savings with some risks. Ultimately, the best choice for you depends on your personal financial circumstances, goals, and risk tolerance.
Before making a decision, consult with a trusted mortgage specialist who can provide personalized guidance based on your unique situation. This is exactly why we always recommend working with a mortgage advisor who has decades of experience. Times are constantly changing, so partnering with an advisor who has weathered the storm is a very wise idea. Our team at Wilkes Mortgage is ready to be by your side in making an informed decision that aligns with your long-term financial objectives and sets you up for success as a homeowner.