Variable or Fixed: What’s Your Mortgage Pleasure?

Sorting through mortgages involves making a lot of critical choices.  One of those choices may be deciding between between a fixed- or variable-interest-rate mortgage financing. Fixed-rate mortgage payments are fixed throughout the life of the loan whereas adjustable rate mortgages a/k/a variable rate mortgages a/k/a ARM’s can have rate and payment changes at certain set intervals.  The adjustable mortgage interest rate is calculated using an index plus a margin, which means payments could move up or down depending on prevailing interest rates. In addition, there are payment caps, annual caps, and lifetime caps. The most common indexes to which the interest on adjustable-rate mortgages is pegged are the 1-Year Constant Maturity Treasury Index, The Cost of Funds Index, and the London Interbank Offered Rate Index. Caps and margins vary.

Fixed-rate mortgages rates and payments remain constant despite the interest-rate climate. They generally have higher initial interest rates than variable-rate mortgages.  In an increasing rate environment, they are a borrower’s choice. Should rates move lower, borrowers with a fixed rate mortgage would have to refinance in order to take advantage of lower rates which may involve closing costs, and additional paper work.

The initial interest rates and payment on ARM’s are often lower than fixed rate products with the rate and payment subject to change (up or down).   ARM’s may allow borrowers to take advantage of falling interest rates without refinancing, and rollover refinancing strategies can be implemented so that the average of the rate over a period of time is cost effective (although never guaranteed).

So what’ll be?  Fixed or adjustable?  Think about the following broad considerations before choosing:

1. How long do you plan to stay in the home? If you plan on living in the home a short time, you may want to consider a variable-rate mortgage. With a shorter time frame, the loan rate will have less time to move up or down and risk is minimized
2. Where are interest rates headed?  If interest rates are historically low, it may make sense to consider a fixed rate. On the other hand, if interest rates are higher than historical averages, it may make sense to consider an ARM. Should rates drop, your payment and rate may also.
3. What are the terms of the ARM? When does the rate and payment adjust?  How frequently can the rate be adjusted? Are there annual and lifetime caps? Is there a limit on how much it can be adjusted in each period?
4. Could you still afford your monthly payment if interest rates were to rise significantly? How would it affect your finances if your payment were to rise to its lifetime limit and stay there for an extended period?

Buying a home is a major commitment. Selecting the most appropriate mortgage for your short and long term goals may make that long-term obligation more manageable.