Which loan saves you money on your mortgage — ARM or Fixed?

If you’re buying a house or considering refinancing, at some point you will wonder if an ARM would save you money on your mortgage. ARM or fixed — which one is best? That depends on three things:

  1. Where you think rates are going over the next few years
  2. How much lower the rate is for an ARM vs. a fixed
  3. How long you plan on holding onto the mortgage

Let’s look at the first factor in deciding whether to take an ARM or a fixed — where you think rates are going over the next few years. If you think rates are going to be stable or perhaps even declining when your loan starts to adjust, you would feel comfortable going with an ARM. Why is that? Because an ARM has interest rate risk. ARMs are typically fixed for 5, 7 or 10 years, then they start to adjust every year. When the initial fixed period is up, you have interest rate risk. If you think rates will be pretty much the same five years from now as they are today, you would go with an ARM and still be able to sleep at night. But if you were fairly certain rates would be higher five years from now, then you should go with a fixed.

The second factor is pretty important: is the ARM interest rate a lot lower than the rate for a 30 year fixed? Because if the ARM is only 1/8% to 1/4% lower than the fixed, most people would say go with the fixed. You’re not saving enough money on your mortgage to make the interest rate risk worth it. But if the ARM is 1/2% or more cheaper, then it might start to make sense.

#3 is probably the most important factor of all — how long you plan on holding the mortgage. If you’re fairly certain you’ll be moving in five years, then you’d be safe taking a 5 year ARM. The loan will start to adjust six years from now, but you will have sold the house by then and paid off the loan. You might not sell the house but still pay off the loan through refinancing. How would that happen? Let’s say you’re going through medical school when you buy the house. You need low payments for five years, but once you’re done, your income will shoot up. Once that happens, you can refinance your loan into a fixed rate.

The best way to decide whether to take an ARM or a fixed is to compare rates and payments.  For more information on how ARMs work, see Shopping for an ARM? 3 Things You Must Know. Or call Amerifund at (888) 650-7316 to speak to an experienced loan officer. If you prefer, fill out this form and someone will contact you.

(c) Copyright Eris Saari 2016, 2019