Fixed-Rate or Adjustable Mortgage: Which is Better for You

Fixed-rate or ARM? That's a question many prospective homeowners have to ask themselves before applying for a mortgage in Austin, Texas. There are pros and cons to both options, so it's important to understand how they work and the risks and benefits to both.

A Closer Look at a Fixed-Rate and Adjustable Rate Mortgages

With a fixed-rate mortgage, you pay one set mortgage payment every month for a span of 15 to 30 years. Your payment never changes during that time. Interest rates are higher if you choose a 30-year mortgage loan, but your payment is smaller. If you can afford a 15-year loan, your home will be paid off in 15 years and you do get a substantially lower interest rate.

If you apply for a 30-year fixed-rate mortgage of $150,000 at an interest rate of 4.25, your monthly mortgage payment would be almost $740. Borrowing $150,000 for 15 years with a 3.25% interest rate increases your payment to $1,050 a month, but you'll save a bundle on interest.

Adjustable rate mortgages work differently. You have a set interest rate for a certain period of time, often one, three, five, seven, or ten years. After that, the interest rate adjusts to the present rates. You may start with a very low rate, but years from now, the rate may have doubled, and your new mortgage terms will reflect that new rate and leads to a new payment amount.

With ARMs, there may be caps in place to protect you from exorbitant increases. For example, if your beginning interest rate is 3% and five years later the interest rate is 7%, a 2% cap protects you from the 4% increase in one shot. You'd go to 5% at the next increase. If there is no cap, you will go straight from 3% to 7%.

When to Choose Fixed-Rate and Adjustable Rate Mortgages

Fixed rate mortgages are optimal if you want a payment that will never increase, but you do pay more interest at the start. There is definitely a benefit to having a payment amount that remains steady throughout the 15- or 30-year mortgage, however. It's an ideal loan option for someone who plans to stay in their home forever. On the negative side, if your debt-to-income ratio is close to or over the recommended 43%, you may not qualify for this type of mortgage.

Adjustable rate mortgages are definitely less expensive due to the lower interest rate. The risk of an increased monthly payment can be a problem, however. If you're considering an ARM, it's best if you plan to move when or before the ARM terms are up. If you expect to move once you have children in five years, a five- or seven-year ARM may be ideal for you.

When you apply for a mortgage in Austin, Texas, talk to your lender or mortgage broker about the benefits and risks you face with each mortgage type. These experts can run the numbers using different scenarios and help you find the perfect mortgage loan for your needs.