Making the Fixed or Adjustable Mortgage Decision

If you are going to buy a home, you have excellent timing. The real estate market is down, which means you can get a great deal. You’ll need financing, which means making the fixed or adjustable mortgage decision.

Before choosing a mortgage, it is vital that you do one thing. Get preapproved! There is an ongoing credit crunch at the moment. This means you can have everything in line to get a mortgage and still have problems arise. This can be a disaster in the middle of an escrow period that is quickly expiring. Preapproval lets you get on with the house shopping secure in the knowledge you have money.

The fixed versus adjustable rate mortgage decision is not an easy one. Essentially, the issue boils down to risk versus expense. Let’s take a closer look.

A fixed rate mortgage is the traditional loan that has been around for a very long time. Specifically, your parents probably had a 30 year fixed rate mortgage. The advantage of the loan is stability. Regardless of what the markets are doing, you always know what your interest rate and payment is going to be.

There is a downside to the fixed loan. Since the bank is taking the risk of interest rates moving up and down, it arbitrarily shifts some of that risk to you at the outset of the loan. It does this by bumping up the interest rate you will be charged. Over a long loan, this can mean tens or hundreds of thousands of additional dollars paid in the form of interest.

In contrast, the adjustable rate mortgage is one in which you share some of the risk of the cost of money changing. An “ARM” has an interest rate that changes quarterly, semi-annually or annually depending on the agreement. Since the lender is taking less of the risk of getting stuck with an unprofitable loan, it gives you a break on the interest rate. The initial rate could be as much as 2 to 3 percent less than a similar fixed rate loan. That saves you a lot of money on interest and can cut the monthly payment significantly as well.

There is a major potential negative to the adjustable mortgage. Simply put, it has to do with risk. You risk interest rates going up over time. As the rates move up on your loan, your monthly payments go up as well. It is not unrealistic to be in a situation where rates on adjustable loan rise above fixed rate loans. Obviously, that would be a disaster for many people.

So, which should you choose? Well, there is no right answer per se. It really comes to down to risk versus stability.  If you want more stability, you should consider the fixed rate loan. If you want to save every buck and risk doesn’t bother you, then the ARM is probably your best bet.

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