Which is the better mortgage option for you: fixed or adjustable?
Adjustable-rate mortgages (ARMs) can be very tempting to homebuyers, yet they carry a great
deal of uncertainty. What if rates rise again? That's why more than 75 percent of homeowners
still opt for a fixed-rate mortgage.
Here are three important questions to answer when deciding whether to choose an ARM or
fixed-rate mortgage:
- How long do you plan on staying in the home?
If you're only going to be living in the house a few years, it would make sense to take the
lower-rate ARM, especially if rate adjustments are made only every three years.
- How frequently does the ARM adjust, and when is the adjustment made?
After the initial fixed period, most most ARMs adjust every year on the anniversary of the
mortgage. Some ARMs adjust every three years, based on yields on three-year Treasury
securities. The new rate is actually set about 45 days before the anniversary, based on the
index at that time.
- How high could your monthly payment go if interest rates rise?
Example: On a $100,000 adjustable-rate mortgage, there is maximum annual increase of
two percentage points and a lifetime cap of six percentage points. Note: This is a
worst-case scenario in that the interest rate rises to the maximum 2 percent each year.
Still, you need to ask if you can afford the highest possible payment in such a worst-case
situation.
| Year of ARM |
Rate |
Monthly Payment |
| First year |
5.75% |
$583.57 |
| Second year |
7.75% |
$713.46 |
| Third year |
9.75% |
$850.95 |
Fourth year
(6% lifetime cap) |
11.75% |
$993.04 (up $409.47 more than first
year) |
Now, let's compare this worst-case ARM scenario to a fixed-rate mortgage:
| Interest rate during 4
years |
Total payments during 4
years |
| ARM: 5.75% to 11.75% |
$37,692.24 |
| Fixed rate: 7.75% |
$34,387.79($3,304.45 less) |
In the above case, the fixed-rate mortgage costs less than the worst-case ARM scenario.
Experts say when fixed mortgage rates are low, they tend to be a better deal than an ARM,
even if you only plan to stay in the house for a few years.
Calculator
Check out the Bankrate.com "Should
you get a fixed or adjustable-rate mortgage?" This calculator will give you both the
best- and the worst-case scenarios for an adjustable-rate mortgage.