When shopping for a mortgage, borrowers are usually faced with two primary options: a fixed rate mortgage and an adjustable rate mortgage (ARM). But what is the difference between a fixed rate and adjustable rate mortgage?
Simply put, a fixed rate mortgage locks in a consistent interest rate for the life of the loan, while the interest rate with an adjustable rate mortgage will change after an initial fixed-rate period. This means that if interest rates go up, the rate on an ARM will go up — and theoretically that if interest rates drop, those with an ARM can take advantage of lower rates at the time of adjustment. (There are also limits, or “caps” and “floors,” on how much the interest rate can fluctuate — more on that below.)
The interest rate on an ARM will change, so it could be a good choice for borrowers who are looking to move or refinance in a shorter amount of time. The following questions may guide your decision of whether or not an ARM is right for you:
Unlike with fixed rate mortgages, which are virtually the same from lender to lender, adjustable rate mortgages offer more flexibility. This can be good news to borrowers who have done their research, but can also get a little overwhelming for anyone else. Let’s look at some of the most popular types of ARMs, as well as interest caps.
Interest rate caps limit the interest rate on an ARM, and can be an initial interest rate cap, a periodic interest rate cap, or a lifetime interest rate cap.
Just as the above ARM types are written in a type of code, so are interest rate caps. Generally, the first number is the initial cap, the second is the period cap, and the third is the lifetime cap. For example, if an ARM is set up as a 5-2-5 structure, that means that the first adjustment can’t go above or below 5 percent, the subsequent adjustments can’t increase or decrease more than 2 percent, and the lifetime cap is 5 percent up or down.
If all of these numbers have your head spinning, don’t worry. The mortgage professionals at Mr. Cooper can walk you through all of your loan options, including adjustable rate mortgages, fixed rate mortgages, and many more. Click here to get started.