The age old question: “Which mortgage is right for me?”
After all, the choice you make today will affect your checkbook for years to come. So it’s important to take your time and put care and research behind your decision.
Yes, it will involve a mortgage calculator, notes, and most importantly, your precious time. We’re not shopping for a television here folks. We’re talking about one the biggest financial decisions of your life.
Two Main Mortgage Categories – Fixed & Adjustable
- You basically have one major home loan choice to make
- Go with a fixed-rate mortgage and never worry about your interest rate increasing
- Or choose a cheaper ARM and risk a major payment jump in the future
- Either way you still need to keep an eye on interest rates over time
Well, the answer depends on your unique financial position, the state of the economy, and your own individual risk appetite.
If you’re the type that likes to play it safe, a fixed-rate mortgage is probably the best choice, hands down.
With a FRM, you won’t have to worry about the interest rate changing at all throughout the life of the loan, which means you won’t ever see your monthly mortgage payment increase.
This is certainly great peace of mind, but you do pay a bit of a price for it.
Currently, mortgage rates on 30-year fixed loans are hovering around 4%, while 5/1 ARMs are pricing about a half point to a full percentage point lower.
30-Year Fixed Mortgage: 4.00% (rate never changes over 30 years)
5/1 ARM: 2.99% (rate can change once annually after first five years)
That brings us to adjustable-rate mortgages. These days, most ARMs are in fact hybrid ARMs, meaning they’re fixed for a certain period of time before becoming adjustable.
One of the most popular ARMs is the 5/1 ARM, which is fixed for the first five years of the loan term, and adjustable for the remaining 25 years.
This means you get five years of absolute certainty, followed by 25 years of the great unknown.
Of course, you get a “discount” for taking on that risk, in the form of a lower mortgage rate. However, the big question is whether it’s worth it. Again, this depends on a number of factors.
If you’re not quite convinced an ARM is for you, take a look at longer-term ARMs, such as the 7/1 and 10/1 ARM, which are fixed for seven and 10 years, respectively, before becoming annually adjustable. That way you get the best of both worlds.
Fixed-rate or adjustable-rate mortgage aside, you’ll need to decide on a mortgage term as well.
Your Unique Situation Will Dictate Mortgage Choice
- There isn’t one right mortgage out there
- Product choice will vary tremendously based on personal preference
- Along with what you can afford, what you plan to do with the property, and so on
- It’s important to consider all the options available to make the right decision
Below, I’ve highlighted some reasons why you’d maybe go one way or another.
We have to consider personal risk appetite, tenure (how long you’ll keep the property), mortgage payoff goals, ability to refinance, and more.
Simply put, a wealthier homeowner has more options, whereas someone who earns less may only be able to afford the 30-year fixed. And also won’t be able to take chances on an ARM. End of story.
A 15-year fixed could be the best choice for conservative borrowers with deep pockets, especially if you want to pay off your mortgage early.
The monthly payment will be significantly higher because of the shorter term, but you’ll pay a lot less in interest and own your home free and clear a lot sooner.
If that’s what you’re looking for, it’s possible to take things a step further and make it a 10-year fixed too.
There’s even a 15/15 ARM now, which is fixed for 15 years before adjusting just once at the halfway point. That could satisfy even the biggest ARM-hater.
For the record, most homeowners move within six years, so many of these ARMs wouldn’t even make it to the first adjustment period before being paid off via a sale.
But others might have their eyes on a forever home, with no interest in ever leaving or applying for another mortgage.
So there’s no one-size-fits-all mortgage out there, it really depends on the individual.
If You Don’t Like Risk…Think Fixed
- If you are risk-averse and don’t want to stay up at night worrying about your mortgage rate rising
- Or can’t handle a larger monthly mortgage payment if your mortgage rate adjusts higher
- And plan to stay in your home for the long-haul and pay off your mortgage
- A fixed-rate mortgage may save you money long-term especially since they’re so cheap right now
If You Are Open to Some Risk or Plan to Stay for Only a Short Time, an ARM Might Work
- If you don’t plan on staying in your home for a long time (you may move or upgrade)
- Or think mortgage rates may hold steady or drop in the future, allowing you to refinance to a lower rate later on
- Or don’t want to pay off your mortgage because you think you can do better investing your money elsewhere
- A lower-rate ARM might be the better option to save some money
Want to Own More of Your Home Sooner?
- It’s possible to own more of your home faster with either a 15-year fixed or an adjustable-rate mortgage
- Because a greater amount of money will go toward the principal balance each month
- Assuming the interest rate is lower and/or the loan term is shorter
- Just know that 15-year mortgages can be quite expense and ARMs can adjust higher
If You Want to Pay Off Your Mortgage Slowly
- In order to keep monthly payments affordable
- And/or to put your more of your money to use somewhere else
- You may want to go with a long-term fixed mortgage like the 30-year
- Or a cheaper ARM that you can refinance if and when necessary
If You Want the Lowest Rate on Your Mortgage
- Assuming risk isn’t an issue for you either because you plan to move or you’re wealthy
- The lowest interest rate will generally come on a short-term ARM
- Such as the 3/1, 5/1, or 7/1 ARM
- Those who can afford it may also consider the 15-year fixed
If You Want to Tap Equity
- Existing homeowners looking to tap into their equity
- Can go with a cash-out refinance if they want to change their first mortgage’s rate or term
- Or they can tack on a second mortgage via a HELOC or home equity loan
- Seniors have the added option of a reverse mortgage
So there you have it – a primer on what mortgage you should pick and why.
Remember, this is a huge financial decision, and should go well beyond reading one article.
Sit down and compare all available options. Do the math. Do your homework. Make a plan. And SHOP AROUND!
Read more: Do I qualify for a mortgage?