Whether you’re shopping around for your first home, a new home or even an investment property, one of the most important factors to concern yourself with is the mortgage. No two mortgages are created equal and what works for your neighbor, family member or best friend might not work for you at all. The two main types of mortgages that you’ll want to concern yourself with are adjustable rate mortgages (ARM) and fixed mortgages. These two terms refer to the interest rate that you’ll be charged for successfully setting up a mortgage with your lending institution of choice. They are different in a number of very important ways.
As its name suggests, an adjustable rate mortgage is a mortgage with an adjustable interest rate. These types of mortgages often have interest rates that are fixed for a specific period of time, after which they will begin to fluctuate based on criteria like your payment history, the conditions of the market, your credit and more. Oftentimes adjustable rate mortgages are a great way to lock in a low interest rate right at the start of your mortgage. These are ideal for people who may be in a situation where they know they won’t be spending a significant portion of their lives in the house in question. If you’re only planning on staying in a home for a period of seven years, for example, you can likely save yourself a great deal of money on interest payments alone just by going with an adjustable rate mortgage. An adjustable rate mortgage for 7 years is commonly referred to as a 7/1 ARM.
The second main type of mortgage is a fixed mortgage. As its name suggests, the interest rate on these types of mortgages does not vary based on criteria like market fluctuations. The main advantage of these types of mortgages is also the main disadvantage. If you can lock your mortgage into a low, fixed interest rate, you won’t have to worry about it unexpectedly increasing in a dramatic way over the life of the mortgage agreement. However, you also won’t see benefits that people with adjustable rate mortgages might see in a decreasing rate environment. If you lock in at a 5% fixed rate on your mortgage and the market dictates in three years that mortgage rates should be at 2%, for example, or if you’ve increased your credit and are now capable of getting a lower rate on your own, your mortgage rate won’t automatically adjust unless you go through the refinancing process.