Whether you’re buying your first property or your fifth, a mortgage is a significant financial responsibility. Fortunately, it’s not particularly complicated. There are really only three major components of a mortgage that you need to compare when selecting which one is right for you:
Interest rates on mortgages are amortized over the full term of the loan so that you pay the same amount every month, but that amount can vary if your interest rate changes. The interest on your loan will either be a fixed rate or a variable rate, each with its own pros and cons.
The main advantage of a fixed-rate loan is predictability. You’ll “lock in” a rate when you sign the paperwork on your loan, and that rate will apply for the rest of the loan’s term, regardless of external market forces. As a result, you’ll pay the same predictable monthly payment for the next 15 to 30 years.
The total amount of interest paid will depend on the principal and term of the loan. For example:
We’ve written in more depth about the pros and cons of 15- and 30-year mortgages here, but in either case, a fixed-rate loan means that your rate of interest and monthly payments won’t change.
An adjustable rate mortgage (ARM) is considerably more complicated. The basic structure is that your interest rate will be fixed for a set amount of time at the beginning of the loan, usually at a rate much lower than the fixed rate you’d typically receive. After that period, your interest rate will change on a regular basis until the end of the loan. Some important terminology includes:
Some loans will offer a cap on monthly payments instead, but any unpaid interest in this case is added to the principal of the loan, potentially leading to a loan on which you owe more than you initially borrowed.
During the initial fixed period, an ARM is typically much cheaper than a fixed-rate mortgage, allowing you to qualify for a larger loan. In an environment where interest rates are likely to fall, you might even benefit from lower monthly payments later in the loan.
That same volatility can work against you, though. If rates climb, your monthly payment could skyrocket in just a few years. The Consumer Financial Protection Bureau has taken steps to prevent predatory loans that might result in astronomical increases in monthly payment, but there’s still an inherent risk.
There are a few situations where an ARM might present significant advantages:
As of the middle of 2021, we’re in the exact opposite situation. Interest rates are as low as they’ve been for nearly 70 years, so signing an ARM in the hopes that they’ll fall is ill-advised.
No matter what your situation, an ARM is something you should consider carefully before signing. At First Western Trust Bank, we can combine our in-depth knowledge of the state of financial markets and interest rates with a holistic examination of your personal finances and goals. The end result is a tailored recommendation and loan that’s right for your circumstances both now and years down the line. If you’re ready to start looking at mortgages, get in touch with First Western Trust Bank today.
