Fixed Rate vs ARM Mortgage: Which is Better?

Most people, regardless of their age or stage in life, look forward to one day to building or purchasing their dream house. The task becomes daunting when you live in a more metropolitan city such as NYC. NYC real estate is one of the most expensive markets in the world. Buying a home in the city could pose significant challenges even for someone who is financially well-off.

Fortunately, there are multiple financing options available to New Yorkers which may help potential buyers turn their dreams into reality. One of those options, an adjustable rate mortgage (ARM) is increasing in popularity given the current economic situation of many during the ongoing pandemic. But what exactly is it and how does it compare to other financing options?

What is an ARM Mortgage?

An adjustable rate, or variable rate, mortgage is one in which the interest rate fluctuates over the life of the loan. This is in contrast to a fixed-rate loan in which the interest rate is locked in and stays the same. An index rate determines the amount of shift interest rates will have over time. Most lenders provide lower rates at the onset of the loan term before switching borrowers to the fluctuating index system. There are caps in place that may limit monthly payments, lifetime rate, or interest rate changes.

ARM is traditionally considered a riskier financing solution due to the shifting interest rates, which, in turn, mean your monthly payments will change depending on the rate’s increase or decrease. However, the recent downturn in the economy has made it a more convincing option. ARM is available with the option of seven or ten-year terms, making it a great option for prospective homeowners who are looking for a low introductory interest rate.

The 7 Year ARM:

As the name suggests, this form of ARM provides for a fixed interest rate for the first 7 years of the loan. Once that period is over the rate will be subject to the fluctuation of indexes and the pre-selected rate caps. This type of loan is best for those who do not plan to stay in a home for more than 7 years. If you can manage to pay the loan off at the end of the fixed term or shortly thereafter, you’ll be a lot better off compared to borrowers who secured conventional loans at higher rates.

The 10 Year ARM:

As with the seven-year ARM, the 10-year arm allows for a fixed interest rate for a term of 10 years. It is good for the same reason as a seven-year ARM–you’re looking at a financial incentive if you managed to pay off the loan during the 10-year term while the interest rate was fixed.

Why ARM is a Better Option:

One of the chief advantages of ARM is that it offers lower interest rates during the fixed portion of the loan and, compared to conventional loan terms, the payment schedule is quite reasonable. Besides, even when the fixed term is over, there is a payment cap to help reduce the risk of astronomical mortgage payments. ARM is better for short-term loans (10 years or less).

The Downside of ARM:

ARM might not be your best option once the fixed term is over and inconsistent monthly payments kick in. Besides, ARM loans tend to be more technical and harder to understand than conventional loans.

FAQs

What is a Fixed-Rate Mortgage?

A fixed-rate mortgage is a type of mortgage where the interest rate remains the same for the entire term of the loan, typically 15 or 30 years.

What are the Advantages of a Fixed Rate Mortgage?

The advantages of a fixed-rate mortgage include predictable monthly payments, protection against interest rate increases, and peace of mind knowing that the interest rate will not change over the life of the loan.

What are the Advantages of an ARM Mortgage?

The advantages of an ARM mortgage include lower initial interest rates and lower monthly payments during the fixed rate period, which can help borrowers qualify for a larger loan.

How do you Choose Between a Fixed-Rate and an ARM?

When choosing between a fixed-rate and ARM mortgage, consider your financial goals, the current interest rate environment, and how long you plan to own the property. A fixed-rate mortgage offers stable monthly payments, while an ARM can offer lower initial payments but comes with the risk of rising interest rates in the future.

Can I Switch from an ARM Mortgage to a Fixed-Rate Mortgage?

Yes, it is possible to refinance an ARM mortgage into a fixed-rate mortgage. Borrowers should consider the costs of refinancing and the current interest rate environment before making a decision.

How can I Compare Mortgage Options?

Borrowers can compare mortgage options by looking at the interest rates, terms, fees, and overall costs of different loan options.  It is also important to consider individual circumstances, such as credit score, down payment amount, and financial goals, when choosing a mortgage.

Is an ARM Rate Worth it?

ARMs can be a good idea, as they can offer lower initial interest rates and lower monthly payments, making them more attractive to some borrowers. However, they also come with the risk of rising interest rates and increased monthly payments over time.

Conclusion:

Whether or not an ARM is best for you depends solely on the vision you have for the future. If you don’t plan to stay in the house long term and are able to pay off the loan within the fixed period then ARM is probably your best option. But if you plan to stay in the house for a long time and don’t want the hassle of inconsistent payments once the fixed time is over, then a fixed mortgage would suit you best.