What Mortgage Program is Right for Me?
How a No Cost Refinance WorksPrior
Should You Pay Discount Points When You Refinance Your Mortgage?Next
What Mortgage Program is Right for Me?
When you speak with lenders about your refinancing it is helpful to have an idea of the type of mortgage program that is right for you. You may consider changing your mortgage program when you refinance. For example, you may want to switch from an adjustable rate mortgage (ARM) to a fixed rate mortgage. It is key to select a program that you are comfortable with and what type of loan you choose also impacts your mortgage rate, monthly payment and what size loan you can afford. We review the three main types of mortgage programs -- fixed rate, adjustable rate and interest only -- below and provide a chart at the bottom of the page that outlines the positives, negatives and key features for each program. Reviewing these resources will help you decide the mortgage program that is right for you when you refinance.
- Fixed Rate Mortgage: The most common type of program is a fixed rate mortgage because it involves the least amount of risk. With a fixed rate mortgage, your mortgage rate and monthly payment can never increase and stay constant over the life of the mortgage. For a 30 year loan, your mortgage rate in month 360 is the same as your rate in month one and your loan payment never changes, despite any fluctuations in the economy or interest rates. The certainty of a fixed rate mortgage provides peace of mind that most borrowers prefer. The downside to a fixed rate mortgage is if interest rates go down you are stuck paying a higher rate and mortgage payment unless you refinance which can be costly and time-consuming. For most borrowers, however, the benefits and certainty of a fixed rate mortgage outweigh the risks.
- Use ourFIXED RATE MORTGAGE CALCULATOR
to determine the monthly mortgage payment and interest expense for a fixed rate mortgage
- Adjustable Rate Mortgage (ARM): Unlike a fixed rate mortgage, the interest rate and monthly payment for an adjustable rate mortgage (ARM) -- also known as a variable rate mortgage -- can change over the life of the loan. The primary reason to select an ARM is because the mortgage rate and monthly payment are lower than a fixed rate mortgage during the initial period of the loan. Because the monthly payment for an ARM is lower you may be able to afford a larger mortgage amount. Another reason to select an ARM is if you think interest rates are going to decline significantly in the future because your rate and monthly payment could go down. An adjustable rate mortgage is a good option if you know you are only going to have the mortgage for a specified period of time, such as if you plan to sell your home within a set number of years. The key downside to an ARM is the risk that your mortgage rate and payment increases significantly in the future during the adjustable rate period of the mortgage. An increased mortgage rate and monthly payment can cause payment shock for borrowers so make sure you understand the risks before selecting an ARM.
- Use ourAdjustable Rate Mortgage Calculator to determine the monthly mortgage payment and worst case scenario for an ARM
- Interest Only Mortgage: Interest only mortgages are the riskiest and least common type of loan program. As the name suggests, the with an interest only mortgage you pay only interest and no principal for a set period of time, called the interest only period. Following the interest only period you pay both interest and principal plus the mortgage turns into an adjustable rate mortgage, so your mortgage rate and monthly payment can increase and potentially significantly. The primary reason to select an interest only mortgage is because the mortgage payment during the initial interest only period of the loan is lower than the payment for a fixed rate mortgage or an ARM, because you are not paying principal. Additionally, you can typically qualify for a larger mortgage amount with an interest only mortgage. An interest only mortgage also gives you the flexibility to pay down your principal balance on your schedule as compared to the regular amortization schedule for a fixed rate mortgage. The downsides to an interest only mortgage are that your mortgage payment increases after the initial interest only period when you start paying both principal and interest plus your mortgage rate can also increase. This would cause your monthly payment to go up even more which creates the potential for significant payment shock.
- Use ourInterest Only Mortgage Calculator to determine the monthly mortgage payment and worst case scenario for an interest only mortgage
- How to Select the Mortgage Program that Best Meets Your Needs
So what mortgage program is right for you? It all depends on you risk profile and financial goals. If you are looking for certainty, then a fixed rate mortgage probably works best. If you have a higher tolerance for risk and are looking for a lower monthly payment or larger mortgage amount, then an Adjustable Rate Mortgage or Interest Only Mortgage may be right for you.
If you know you are only going to live in the home for a relatively short period of time such as three to ten years and you are going to sell your home before the adjustable rate period for an adjustable rate mortgage or an interest only mortgage begins, they could be the right program for you. That way you benefit from the lower monthly mortgage payment during the initial period of the mortgage but you are not exposed to a potential increase in interest rates and mortgage payment during the adjustable rate period when the interest rate and mortgage payment can change and potentially go up on an annual or semi-annual basis. This approach is not without risk either, as there is no guarantee you could sell your property for more than you paid for it.
Review our What Mortgage Program is Right for Me? instructional video to understand your refinance options.
What Mortgage Program is Right for Me? Instructional Video
Part of your decision depends on what direction you think mortgage rates are heading. If you think mortgage rates are going to increase in the future, you should select a fixed rate mortgage. If you think rates are going to go down, you may want to consider an adjustable rate mortgage or possibly an interest only mortgage. It is very challenging to predict how mortgage rates will change in the future, especially over the long term, so trying to take advantage of a potential shift in rates should not be your primary reason to select a mortgage program.
We recommend that you use the comparison chart below to determine the mortgage program that is right for your refinance. In addition to outlining how the programs work and summarizing their positives and negatives, the chart assesses the risk level for each program and addresses key loan features including mortgage rate, loan term and amortization. The chart also compares mortgage payments and identifies which program is best, depending on the interest rate environment. As illustrated by the chart, each program is suitable for a specific type of borrower with a unique risk profile and financial objectives. Review the chart below to learn about each type of mortgage so you can choose the program that best meets your refinance goals.
Mortgage Program Comparison
Fixed Rate Mortgage
Adjustable Rate Mortgage (ARM)
Interest Only Mortgage (IO ARM)
- Interest rate and payment do not change over the life of the mortgage
- Fixed interest rate and payment for first 3, 5, 7 or 10 years (fixed rate period)
- Then interest rate and payment can change (adjustable rate period)
- Pay only interest at fixed interest rate for first 3, 5, 7 or 10 years (interest only period)
- Then pay both principal and interest plus interest rate and payment can change (adjustable rate period)
- Lower interest rate and payment during fixed rate period
- Lower payment if rates go down
- Lower payment during interest only period
- Qualify for larger mortgage amount
- Higher payment than ARM or Interest Only
- Locked into interest rate if you cannot refinance
- Potential increase in interest rate and payment
- Payment increases when you start paying principal
- Potential increase in interest rate
10-40 years 30 years most common
Only for part of term
- Depending on term, higher rate than ARM or interest only mortgage
- Initial teaser rate lower than fixed rate mortgage
- Initial teaser rate lower than fixed rate mortgage
Can interest rate increase?
Can interest rate decrease?
Initial Mortgage Payment
Lowest possible monthly payment
Highest possible monthly payment
Going to own property for short period of time
Going to own property for entire term of mortgage
Think interest rates will go up significantly
Think interest rates will go down significantly
Best for low interest rate environment
Best for high interest rate environment
Contact lenders in the table below to learn about the programs they offer and to determine the refinance program that best meets your needs. Comparing lenders and loan terms enables you to find the mortgage program that is right for your refinance.
‚ÄúUnderstand loan options.‚ÄĚ CFPB. Consumer Financial Protection Bureau, 2017. Web.
"Fixed Rate and Adjustable Rate Mortgages." FDIC. Federal Deposit Insurance Corporation, October 14 2016. Web.
About the author