The differences between a fixed and adjustable rate mortgage

When you are in the market to buy a house, you have two mortgage options: fixed-rate and adjustable-rate.

Both will provide you the money needed to buy the home you have your eyes set on, but there are key differences between the two that are important to consider. Rushing into a rash decision can leave you in trouble financially later on if you aren't careful.

What is a fixed rate mortgage?
Fixed rate mortgages are the most common type homebuyers seek out. When you get a FRM, the interest rate remains the same during the duration of the loan. Essentially, you'll pay the same amount every month until your remaining balance is eliminated.

Now you have to decide whether you want to get a 30-year or 15-year mortgage because the duration of the loan will have an impact on your monthly payments. If you want lower monthly payments, go with the 30-year FRM. But keep in mind that rates will be higher, which means you pay more in interest over the life of the mortgage.

Likewise, a 15-year FRM offers lower interest rates, but higher monthly payments because of its shorter lifespan.

According to the latest information from Bankrate, interest rates for mortgages at the end of March 2016 for a 30-year FRM were 3.83 percent, while 15-year rates were 3.09 percent.

Mortgage application.

Mortgages are offered in fixed or adjustable terms.

What is an adjustable rate mortgage?
As its name implies, an ARM can change, with the most important factor being interest rates. ARMs are unique because they typically come with a fixed rate period near the beginning. But once that period ends, your monthly payments can either increase or decrease depending on interest rates.

This distinction is something you have to consider if you're looking at ARMs. You can secure a loan now while rates are low and hope they remain low once the fixed rate period is over, and you'll end up saving money. However, no one can ever predict the future, and there's a risk rates and your payments may increase by more than you were expecting.

Additionally, ARMs interest rates are influenced by one of the three major indexes, Bankrate stated. These are:

  • London Interbank Offered Rate
  • Weekly constant maturity yield on one-year Treasury bill
  • 11th District cost of funds index

Unlike a fixed rate mortgage, most ARMs are offered as a 5/1. Essentially, for five years the interest rate remains fixed, but after that, it changes every year.

Which is right for me?
Your mortgage choice is entirely up to you, but there are some other factors that can help you make a decision.

"Your mortgage choice is entirely up to you."

Interest rates should always be taken into account. Currently, rates are lower when compared to 10 years ago. According to Freddie Mac's historical data, the 30-year FRM rate in April 2006 was 6.51 percent. Today's rate is 2.85 percentage points lower, and the Federal Reserve recently stated they are being cautious about further benchmark rate increases in the coming months.

Your future plans
Where you currently are in your life can also have an impact on the mortgage you choose to get. It makes more sense to opt for a FRM if you have a stable career, enjoy the neighborhood and are at the point in your life where you want your kids to grow up in a stable environment.

But if you see yourself moving in the coming years and generally live a more mobile lifestyle, than an ARM may be your best bet because it lets you keep long-term plans open. According to NerdWallet, you can benefit from the introductory rate of an ARM before monthly payments start to increase or decrease.

When you decide to buy a home, it's important to consider how you will pay for it. Luckily, you have two options to help you buy the house of your dreams.

For more information about smart ways to manage your finances, contact Landmark Bank.

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