A Comparison of Adjustable and Fixed Rate Mortgages

Over the span of 30 years, interest adds up on any mortgage. You end up spending thousands on interest alone. In fact, if you borrow $200,000 in a fixed rate mortgage and have an interest rate of 4.5%, the interest on that mortgage totals approximately $164,800 at the end of the 30 years. You've paid almost as much in interest as you did on the house you purchased. It is for this reason that many first-time homeowners start to look more closely at adjustable rate mortgages (ARMs).

The Difference Between an ARM and a Fixed Rate Mortgage

An adjustable rate mortgage typically comes in an option of 3/1 to 10/1. These home loans work by locking in a much lower interest rate for a set number of years, typically three, five, seven, or ten years. At the end of that time, your interest rate and home loan payment is adjusted to match the current interest rate.

This differs from a fixed rate mortgage where you lock in an interest rate for the life of the loan. While current interest rates on an ARM may be very low and appealing years from now, the interest rates may be double. Your newly adjusted mortgage payment could be twice what you are paying now. ARMs, therefore, end up being a gamble.

When are ARMs Best?

ARM home loans are excellent options when you know you will not be staying in your new home for more than a few years. If you're purchasing a starter home and know you will be moving as you begin having children, an ARM is ideal. You save money on your monthly mortgage payment, and you can put the savings towards the down payment on a larger home in a few years.

If you do take out an ARM and decide to stay in your home, you can always apply for a refinance and switch to a fixed rate mortgage at that point. The risk then becomes how well you qualify for a new loan. If your credit score is good and your debt-to-income ratio is 43% or lower, you shouldn't have a lot of problems switching over.

When are Fixed Rate Mortgages Best?

If the home you intend to purchase is large enough to last a lifetime, or it's a home you know you will stay in for decades, a fixed rate mortgage is ideal. While you will pay more in interest, you have the assurance that the home loan interest rate will never increase. Even if interest rates triple, your interest rate remains the same.