When it comes to getting a home loan, there are two basic loan structures to choose from: Fixed Rate Mortgage and Adjustable Rate Mortgage, or “ARM.” The type of loan you choose will depend largely upon your particular financial situation.
With a fixed rate loan, the interest rate is set at the beginning of the loan and that amount stays the same during the entire course of the loan. Those loan rates are determined largely on the condition of the economy at the time the loan is secured. Lenders have a vested interest in protecting their money, and if the economy indicates that the economy is due for a serious fluctuation, they interest rate is likely to be higher than it would be if the economy were more stable.
An adjustable rate mortgage, by contrast, is more flexible, and still allows the lender to protect himself against fluctuations in the market. If the increase in rates reaches a certain threshold during the life of your loan, the lender can adjust the interest rate charged to you, which will affect your payment amount for the balance of the term.
Pros and cons of going the ARM route
You may wonder why you would want to go with an adjustable rate mortgage, if there’s a possibility that your rate could go up. Yes, there is a potential for your rate to go up, however, the initial ARM rate could be set lower than the fixed mortgage rates, which means that more borrows could potentially qualify for that kind of loan because the lender has the safety net to increase the rate if the interest rates go up over a predetermined amount of time.
The pros and cons of fixed rate mortgage
Initially, fixed rate mortgages are generally higher than ARMs, so that that rate can be locked in regardless of what the market does. That prevents the lender from losing money. On the flipside, if the market falters and rates go down, the lender has the security of the previously locked in rate, so there’s no risk to them. As the borrower, you can rest assured that your rate won’t change, which makes it much easier to budget and plan for the future. You cannot be “priced out” of affording your home because of constant mortgage adjustments. In general, fixed rate home loans are more favourable to the borrower than the lender, though of course this is not universally true.
As you can see, there are a varieties of pros and cons for both fixed rate mortgages and adjustable rate mortgages. Which option is best for you depends on many factors, and it’s important to talk to your bank or lender to determine which route might be the best for you to take. Whichever option you choose, always shop around to ensure you are getting the best rate possible. Buying a home is probably the biggest purchase you’ll ever make, and it’s important to ensure you aren’t paying any more than you need to.