The Difference Between a Fixed Rate Loan vs. An Adjustable Rate Loan

The Difference Between a Fixed Rate Loan vs. An Adjustable Rate Loan

You’re about to purchase your first home, but first your mortgage lender wants to know: fixed rate mortgage or adjustable rate mortgage? Both loan products have their place, but you need to be careful — the choice can have some significant consequences.

Fixed Rate Loans vs. Adjustable Rate Loans

Just like a credit card, a mortgage loan has an interest rate: the amount of interest that is charged by the bank every year. A fixed rate mortgage is easy to understand. It’s just a mortgage with a static interest rate. A 3.5% fixed rate mortgage will always be a 3.5% fixed rate mortgage.

An adjustable rate loan is different. An adjustable rate mortgage (ARM) often starts off with a low introductory rate. However, the interest rate changes based on the current costs of the loan servicer. Often, an adjustable rate mortgage will increase in interest over time.

What are the Advantages and Disadvantages of an Adjustable Rate Loan?

The rationale behind a fixed rate loan is clear: you get a guaranteed interest rate throughout the term of your loan. Your mortgage payments will remain the same. But what are the advantages of an adjustable rate loan?

An adjustable rate loan often starts out with a lower initial rate than a fixed rate loan. Those who have bad credit may find that an ARM is affordable but a fixed rate loan is not. And while an ARM does go up over time, many people assume that they will be able to refinance at a fixed rate before it does so.

Essentially, an adjustable rate mortgage is a bit of a gamble. You don’t have a guaranteed interest rate, but you may be able to purchase a larger property, or better qualify for a property. If you are able to refinance later on, you may be able to get a low interest rate now, and a fixed rate mortgage later.

Should You Get a Fixed Rate or Adjustable Rate Mortgage?

Before you make a decision, you should compare the different mortgage products you’re being offered. Both the interest rate and the type of interest are going to factor in. An adjustable rate mortgage may let you purchase more home, but you need to consider whether that properly fits into your budget. A fixed rate mortgage may have more strict qualifications, but it can save you thousands of dollars.

Navigating the mortgage experience can be complex, and there are a lot of things to consider. Work with your mortgage loan officer and your real estate agent to find the right product for you.