There are two main types of mortgages — fixed–rate and adjustable–rate — that have been serving families for decades. Each mortgage comes with its own set of features and benefits that should be carefully considered before choosing one.
Fixed–rate mortgages are the most common type of mortgage today, with over 90% of homebuyers choosing it.
Why is it so popular? With a fixed–rate mortgage, your interest rate will be locked in for the life of the loan. This means that your monthly mortgage payments will remain the same for the entire term of the loan, whether it's a 15–, 20– or 30–year mortgage.
Let's say you lock–in today with a 30–year fixed–rate mortgage at 4.5% and your mortgage payment is $1,200 per month. With a fixed–rate mortgage, your payment will be the same in 12, 18 and 26 years, assuming you haven't tapped into your equity or refinanced your mortgage. No matter how high rates may rise over the next 30 years, your payment will always be based on your 4.5% rate. [Your taxes and insurance costs will likely increase, however.]
The benefit of the fixed–rate mortgage boils down to "inflation protection" and offers peace of mind in today's market. If mortgage rates increase, your mortgage rate will not change during your mortgage term. If rates go down, you can always refinance, usually without penalty.
An adjustable–rate mortgage (ARM) is a loan with an interest rate that will change during the life of the loan. An ARM may start out with lower monthly payments than a fixed–rate mortgage, but it's important to know your payments can go up over time, and you'll need to be financially prepared for the adjustments.
If you're seeking lower payments in the initial years of your mortgage — with plans to sell your home in less than five years, or less than the adjustment period — an ARM may be attractive since rates are typically lower than fixed–rate mortgages. Just be sure you know the details of how and when your payments may change and evaluate your options carefully.
Let's say you choose a 3/1 ARM and lock–in with a 4.0% interest rate. Your mortgage will stay the same for the first three years, and then can change once a year for the remaining term of the loan. If interest rates increase, your monthly payments will increase, If rates go down, sometimes your payment may go down, but that's not true for all ARMs. Also, some ARMs set a cap on how high your interest rate can go and some limit how low your interest rate can go.
To determine the best type of mortgage that's right for you, lean on your lender or financial professional for guidance. A mortgage is a long–term commitment, and the more knowledgeable and prepared you are, the more successful you'll be.