Choosing a type of mortgage loan is one of the most important decisions you’ll make, when buying a home in the East Bay. After all, your home loan will stay with you until you either pay it off, sell the home, or refinance the loan — and that could be years down the road. So you want to make sure you choose the right type of loan for your situation.
When it comes to interest rate structure, East Bay home buyers essentially have two options to choose from: fixed and adjustable. Let’s explore the pros and cons of each option.
Fixed-Rate Mortgages Offer Long-Term Stability
As the name suggests, a fixed-rate mortgage is when the interest rate stays the same over the life or “term” of the loan. The monthly payment amount stays the same as well.
Predictability is the primary benefit to using a fixed-rate mortgage loan. You always know what your interest rate will be, regardless of what the economy does. Even if East Bay mortgage rates rise during your repayment period, yours will stay the same. It will remain “fixed,” hence the name of this mortgage product.
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The disadvantage is that you might pay a premium for this predictability, in the form of a higher interest rate. Fixed-rate loans typically come with higher interest costs, when compared to ARMs. It’s a trade-off.
- Some East Bay mortgage shoppers are willing to take on a slightly higher rate, in exchange for long-term payment stability. So they choose fixed.
- Other borrowers want to secure the lowest initial rate possible, and that drives them toward the adjustable mortgage.
And speaking of adjustable-rate loans, let’s talk about the pros and cons of those next.
ARM Loans Offer Savings on the Front End
Unlike the fixed-rate loan described above, an adjustable-rate mortgage (ARM) loan has an interest rate that can change over time. This is its primary distinguishing feature, and it’s an important feature to understand.
Here’s how the Federal Reserve defines an ARM loan, in its Consumer Handbook on Adjustable-Rate Mortgages:
“An adjustable-rate mortgage differs from a fixed-rate mortgage in many ways … With an ARM, the interest rate changes periodically, usually in relation to an index, and payments may go up or down accordingly.”
These days, most adjustable mortgages start off with a fixed rate for an initial period of time, usually 3, 5 or 7 years (though it can be shorter). During this introductory or initial period, the interest rate remains fixed and therefore does not change. After the introduction period, however, the rate will begin to change at a predetermined interval — usually once per year.
Here’s where the potential for savings comes into the picture. During the initial fixed period, the interest rate for an ARM loan is often lower than the interest rate on a traditional fixed mortgage for the same amount. That’s the primary advantage of using an ARM to buy a home in the East Bay. You could secure a lower rate for the first few years.
Mortgage Rate Trends Over the Last Year
The line graph below shows average mortgage rates assigned to home loans in three different categories, over the last year or so (at time of publication). It’s based on the weekly market survey conducted by Freddie Mac. As you can see, the average rate for a 5/1 ARM loan tracks slightly below the 15-year fixed-rate mortgage (FRM), and well below the 30-year fixed.
One of the disadvantages to using an ARM loan is that you can never predict exactly how the interest rate will change over the long term (once the introductory fixed-rate period has lapsed). This is the trade-off we talked about earlier.
When using an ARM loan, you might start off with a lower interest rate compared to a fixed loan. But you also have the uncertainty of rate adjustments down the road. So it’s a matter of priorities.
Some East Bay home buyers use ARM loans because they only plan to live in the home they’re buying for a few years. In this kind of scenario, a borrower could benefit from the lower interest rate during the initial period, and then sell the house a few years later, before the loan begins to adjust. (Refinancing is another way to transition out of an ARM loan. But that’s the subject of another article.)
Need Helping Choosing Your East Bay Home Loan?
At Bridgepoint Funding, we take customer education seriously. That’s why we publish helpful articles like this one on a weekly basis. You’ll find our most recent articles on our main blog page. If you’d like to keep up with East Bay mortgage and housing trends, be sure to bookmark our blog.
If you have any questions about which loan product might work best for your situation, please contact our staff. We offer a variety of products and programs, including both fixed and adjustable-rate mortgage loans. We also participate in the FHA and VA loan programs. Our financing experts can help you find the right option for your unique situation.