There are many types of mortgages, but each has two parts: principal and interest. The principal is the amount you borrow. The interest is what you pay to borrow that money. Different home loans give you options on how to structure your interest payments to meet your specific needs.
Your major choice is between a fixed-rate mortgage or an adjustable-rate mortgage (ARM).
One key to the right choice: start thinking about how long you’ll likely stay in your home and what your temperament is like when it comes to change.
With a fixed rate mortgage, your principal and interest payments stay the same for the life of the loan. It’s a good choice if you’re planning to stay in your home for a long time, if you can’t imagine having to move for work, or if you won’t outgrow the home with, for example, a growing family.
Because the interest rate never changes, you’re protected from rising rates for the life of your loan – and you always know what to expect.
- Principal and interest payments stay the same for the life of the loan
- Consistent monthly payments allow you to budget more effectively
- You simply choose from varying loan-length year terms (30-year or 15-year)
With an adjustable rate mortgage (ARM), also called a variable rate mortgage, your Interest rate, monthly principal, and interest payments remain the same for an initial period, then adjust every year based on a rate index.
Typically, ARMs give you lower monthly payments, and they make sense if you expect to move around or if you’re unconcerned about change.
- ARMs have a lower initial interest rate than a fixed-rate mortgage
- While your interest rate can go up, caps set a limit on how high they can go
- You can choose from 6-month, 1-, 2-, 3-, 5-, and 7-year terms
If you’re considering an ARM, it’s a good idea to ask your mortgage lender what your monthly payment would be if interest rates rise 1, 3 or 5 percentage points in the future. Having a handle on different scenarios, and feeling comfortable about what may happen to your monthly payments, is the name of the game.