9/6/2022
Despite the buzz associated with the US real estate market, people still have the urge to buy a new or used home. In this country, you have 2 main alternatives to access a mortgage loan, the fixed interest rate and the adjustable interest rate.
Since this topic is important for your personal finances, we will delve into its main differences.
Before considering a fixed or variable mortgage
The cost of buying a home or refinancing a mortgage loan is usually high due to all the variables involved in contracting it. Still, choosing a fixed or variable mortgage can help you better manage your budget or save on the final amount.
The main distinction between these options can be summarized as follows:
- Fixed-rate mortgage (FRM) does not vary throughout the life of the mortgage loan. Although it usually has a higher rate, the monthly payments remain the same.
- Adjustable-rate mortgage (ARM) usually starts with lower monthly payments. However, as it is subject to economic indicators, both the interest and the installments can go up or down.
- Interest: From 4.75% to 5.75%
- Max term: 30 años
- Interest: Consult
- Max term: 30 años
- Interest: First years fixed-rate and the rest adjustable: SOFR + margin
- Max term: 30 años
- Interest: SOFR + margin
- Max term: 30 años
- Interest: From 5.125%
- Max term: 30 años
What is a fixed-rate mortgage
One way to understand the differences between these financing options is to know each one separately to distinguish its pros and cons. Fixed-rate mortgages are very easy to understand because they are designed not to change until you finish paying.
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The positive part is that you always know your monthly payments and the total amount. The negative: they do not change with economic conditions, and their rate is usually higher than ARMs.
These types of loans are characterized by:
- Be predictable. This quality is focused on avoiding any surprises or sudden changes in interest rates. Being certain that the monthly payments are not going to change is essential, especially if your economic situation suffers some setback. In addition, the final calculation is simpler, you can better organize your finances and more accurately estimate the time to cancel.
- Have higher cost. The shorter the term, the lower the interest rate they will charge you. This means that the predictability has a price that you can assume or not depending on your job expectations, payment strategy or what you expect official interest rates to do.
How does ARM work?
In the United States we have already explained that adjustable-rate mortgages have certain peculiarities in respect to their contracting. Basically, they work the same as in any other country, but they use different schemes.
The truth is that you share the risk with the lender because the interest rate can go up or down depending on economic conditions, affecting the monthly payments.
If you are a person who likes to bet on the change in the real estate market, this option starts with a lower rate. The problem is that this value can also increase at any given time.
It's less predictable than a fixed mortgage, and you could end up paying more if economic conditions raise the rates.
American adjustable-rate mortgages are known for:
- Rate changes. These schemes can be 3/1, 5/1, 7/1, 10/1 being mixed alternatives to pay. That is, you have a period of fixed interest and then the rest is adjustable. In these examples you have the first 3, 5, 7 and 10 years respectively without modification and the rest of the amortization period with a variable rate.
- Indices or indicators. American banks can be governed by the Federal Reserve, bonds, Libor and more recently the SOFR, the index that is substituting the Libor as the most used mortgage rate index. The entities use the value of the indicator and add a spread or margin to establish the payment percentage.
Which option to choose?
If you are thinking about what is the best option for you right now, that will depend on your current financial situation and how you intend to make the commitment.
ARMs are popular mortgage loans because they have the benefit of a low initial rate and plans that can be adapted in various ways to manage your personal finances.
If you think you need to know at all times how much you have to pay, you have a limited budget and you don't like surprises, fixed mortgages may be the most appropriate. Although they may cost you a little more due to their higher interest in combination with long terms that exceed 20 years.
Each particular situation deserves a serious and in-depth study to make the right decision. You can rely on the Busconómico search engine/comparator to find the most interesting options in fixed-rate or adjustable-rate mortgages.
En español: Diferencias entre hipotecas con tasa fija y con tasa variable