Fixed Vs. ARM: Know Which Mortgage Is Right for You

Reviewed: February 22, 2014
By FinanceWeb

When you are shopping for a new mortgage, one of the most important decisions you can make is whether to get a fixed loan or an adjustable ARM. The type of home loan you choose controls your interest rate, payments and the total you pay over the life of the mortgage. Think about your priorities and use these tips to help you choose the right mortgage.

You want a steady monthly payment.

Go with the fixed mortgage. You get a pre-established interest rate for a loan term of 10, 15, 20 or 30 years. Each month you will make a payment for the same set amount. At the start of your loan repayment, most of the money will go toward interest. As you make more payments, more money goes toward the principal balance, which increases your equity in the home. Your minimum payment cannot change unless you refinance the mortgage.

You need the lowest payments possible right now.

Choose the ARM. Interest rates are typically lower, which means your payments will be smaller and you may qualify for a larger home. Keep in mind that your mortgage rate may reset up or down after the initial term. For instance, a 7/1 ARM gives you a fixed rate for seven years and then the interest rate can change every year afterward. Before you sign for an adjustable-rate mortgage, consider what your future may bring and whether you would be able to afford higher payments.

You plan on living in the home for only a few years.

Opt for the ARM. You get lower mortgage payments, which means that you can save money toward the down payment on another home. Since you plan to move before the rate adjustment, you never have to deal with the hassle or the higher payments.

You think interest rates will go up.

Select the fixed mortgage. You will keep a low interest rate for your entire repayment period, up to 30 or 40 years. No matter how much other people’s rates go up, yours will stay the same.

You think mortgages rates will go down.

Try the adjusting home loan. Depending on how your contract is written, your interest charges may drop up to two percent on each adjustment anniversary. Keep in mind that most loan agreements define how high and how low the rates can go. If your guess is wrong and rates increase, your four percent ARM could raise to eight percent in just a few years.

You want a home loan contract that is easy to understand.

Select the fixed mortgage. You pay a uniform cost at an unchanging interest rate over a certain number of years, and then you are done. You can budget for the same expense every month. You do not have to worry about the adjustment indexes, margins and interest caps that come with adjustable-rate mortgages.

ARMs and fixed-rate mortgages both offer significant advantages under the right conditions. No matter what details matter most to you, you can find a home loan that works for your lifestyle.