No two mortgages are exactly alike, as in there are a lot of variables. Once you’ve prequalified for a mortgage, you’ll have the option of choosing the term, or length and whether you get a fixed rate or an adjustable rate. Choosing an adjustable or fixed rate mortgage can have a big impact on how much you pay on your mortgage today and in the future, so it is important that you understand what each option means.
What’s a Fixed Rate?
The concept of a fixed interest rate is fairly simple. The rate you are offered at the start of the mortgage will be the same rate you pay through the life of the loan. That means if your interest rate is 4% on day one of your loan, it will be 4% on the last day of the loan.
One of the big advantages of a fixed rate mortgage is that you can lock in a lower rate when interest rates are lower. Of course, the drawback is that if you take out a mortgage when rates are higher, you are stuck paying a higher interest rate unless you refinance.
What’s an Adjustable Rate?
If you choose to take out an adjustable rate mortgage (ARM), the interest rate on your loan can change with the market, based on the index it is tied to. Usually, the initial rate is fixed for a certain amount of time, such as a year or even 10 years. It is then adjusted to match the market rate. For example, you might get an ARM with a rate of 3.25% for five years. After those five years, the rate can either increase or decrease, depending on how the market is doing.
Your interest rate might be connected to the prime rate, the LIBOR rate or the Fed Funds. While the prime rate and Fed funds have stayed relatively stagnant, the LIBOR rate has started to inch up, which means homeowners with ARMs connected to the LIBOR might soon see a jump in their interest rates.
Can You Switch Between an Adjustable and Fixed Rate?
There are cases when you can swap a fixed rate for an adjustable one and vice-versa. To do so, you will usually have to refinance your mortgage, taking out an entirely new loan. It’s not uncommon for people to want to refinance their ARM into a fixed rate right around the time the ARM is set to reset. Doing so often helps people avoid a significant rise in the interest rate.
It can be difficult to predict what the market will do or how your financial situation will change over the years. When choosing between an adjustable or fixed rate, it’s often best to pick the one that works for you now and that you can comfortably afford. If circumstances change, you can refinance your mortgage to get the new, better rate.