Many people have a difficult time choosing between an adjustable rate mortgage and a fixed rate mortgage. It’s not hard to understand why someone would be concerned. Do you go for the lowest initial rate and hope for the best in years to come, or do you go for the always-safe fixed rate that never changes? The answer to the question really depends on your specific needs and circumstances.

Let’s say you’re buying a house that you only plan to stay in for a year or two. An adjustable-rate mortgage that offers a lower initial interest rate than available fixed-rate mortgages would make more sense. However, if you plan to stay in the house for the rest of your life, an adjustable-rate mortgage may be a great bet. As people who took out adjustable-rate mortgages during the lending industry’s record lows a few years ago can tell you, interest rates can skyrocket in the blink of an eye.

The best way to determine whether to choose an adjustable-rate mortgage or a fixed-rate mortgage is to estimate what will happen to the interest rate and loan payments in specific scenarios. By calculating worst-case scenarios, you can see if you’d be at risk of losing your home if interest rates got out of control. Calculating what-if scenarios can also help you determine whether a fixed-rate mortgage would actually give you a lower monthly payment than your adjustable-rate mortgage if interest rates increased even slightly.

Let’s say you were buying a long-term home for $250,000 and were thinking about taking out a 3/1 ARM with an interest rate of 5 percent, but that rate would only stick for three years. After that three-year period, the rate would fluctuate based on the Treasury rate plus a 2.5 percent spread. On the other hand, you could get a fixed-rate mortgage with an interest rate of 6.5 percent. What should you do?

You can take the adjustable-rate mortgage, but if your interest rate goes up just one percent a year, five years after you buy your home, you’d be paying more for the adjustable-rate mortgage than you would have if you’d taken it out. fixed rate mortgage.

In the scenario above, a $200,000 30-year ARM with a 5 percent interest rate would cost you about $1,075 a month. If that interest rate increases just 1 percent during the first adjustment period, your monthly payment will increase to about $1,190. If the same thing happens at your next adjustment, your payment amount goes up to more than $1,300. Once again, your payment is already about $1,430 a month. To make matters worse, the amount of your payment applied to principal is going down and the amount applied to interest is going up. If you had opted for the fixed-rate mortgage with an interest rate of 6.5 percent, your payments would have remained stable at $1,264 per month. It is not a pretty situation.

While an adjustable-rate mortgage may be a better option for short-term home purchases, people who plan to live in their home for many years may want to avoid the “what-if” scenario and opt for a fixed-rate mortgage instead. .