When you are considering applying for a home mortgage, one of the decisions to make is if a fixed rate mortgage or adjustable rate mortgage is best for you.
The interest rate for a fixed rate mortgage is set when you take out the loan and it will not change. When you have an adjustable rate mortgage, also known as an ARM, the interest rate may go up or down. Interest rates or ARMs often start lower than fixed rate mortgages. This may seem like an advantage, but after the introductory period the interest rate will change and the amount of the payment will likely go up. You will save money at the beginning of the mortgage, but could end up paying more in interest payments over the life of the loan.
Part of the interest rate of an ARM is tied to what is called an index, which is a measure of interest rates. The payment goes up when the index of interest rates moves higher. When interest rates decline, your payment may go down, but that is not always true. Some ARMs will limit the amount of each adjustment and set a maximum on how high your interest rate can go over the life of the loan. Some may also limit howl low the interest rate can go.
Even though the initial payments of an ARM may sound attractive, you need to determine if you will still be able to afford the monthly payments if the rate and payment go up to the maximum amount allowed under the loan contract. One suggestion if you decide on an ARM is to put some of the monthly savings away for when the interest rates increase.
Some people choose the ARM for the lower initial mortgage payments thinking that they will sell their home or refinance the loan before the rate changes. This is not always be possible. If the market values decline in your area, you may not be able to sell your home for enough to pay off the mortgage before the payments increase.
Another assumption is that your income will increase over the years until the interest rates increase. You may not receive the salary increases you were planning or may lose your job. You may also have increased expenses such as having children and other increased living expenses that will make it more difficult to afford the payments when the interest rates increase.
If the value of your home declines or your income declines, you may not be able to refinance your mortgage to a fixed rate mortgage before the ARM interest rates increase. Also, if you have other loan obligations, you may not be able to refinance your mortgage, in order to switch it to a fixed rate mortgage.
When purchasing a home, there are many things to consider. One of the most important is whether to get a variable rate mortgage or fixed rate mortgage. It is important to consider both your current income and expenses, and future income and spending.