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Choosing Between Adjustable Rate and Fixed Rate

When choosing a principal mortgage, one of the most important choices you will make is between an adjustable rate mortgage (ARM) and a fixed rate mortgage (FRM). The decision is based on the contrast of certainty and risk. It is based on, to a certain degree, attempting to predict a future unknown in the form of interest rates at the adjustment period.

If interest rates stay constant or fall in the future, an ARM will certainly save you money when compared to a FRM. This is because ARMs have lower initial interest rates than FRMs, and a very slight rise in rates or stable rates can result in both overall and monthly savings as compared to an FRM. However, this potential reward is countered by the risk that interest rates will rise. Even when caps on interest rates for ARMs are taken into account, there is still the risk that after the initial period, the interest rate and monthly payments on your ARM will be higher than those for an FRM.

To determine which of these options is right for you as a principal mortgage, you should calculate how much interest you will pay on the FRM in the time you have the loan. You should then calculate both the interest you will pay if rates remain constant and if rates rise sharply (worst case scenario) for your ARM. You may also want to figure out some intermediate scenarios for the ARM. You should then compare these to the FRM in order to determine which loan is best for you.

This determination is not standardized. Rather, it will depend on your individual tolerance for risk, as well as your ability to withstand the possibility of higher payments for the ARM. Another important factor in the calculation is the amount of time you plan to keep the loan. If you plan to move and sell the house fairly early, the risk of an ARM will be minimized.


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