How to Choose Your Mortgage Type

What you need to know about deciding between a fixed-rate or adjustable-rate mortgage.

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At the moment, adjustable-rate mortgage rates are being offered for roughly one-and-a-half percentage points below fixed-rate mortgage rates, which makes them tempting. Zillow's Mortgage Marketplace, which tracks real mortgage rates offered to consumers, reports that the average rate on a 30-year fixed-rate mortgage was 4.72 percent last week, while 5/1 ARMs were going for 3.22 percent.

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On a $300,000 mortgage, you'd be looking at a difference in payment of $260 per month and over $3,000 annually, which is certainly significant. But while it may seem like a no-brainer, there are risks associated with mortgage payment once the ARM adjusts. But it's more than likely that the fully indexed rate will be higher than your initial start rate, and you should certainly plan for it to be so. Therein lies the risk of the early discount.

So if you opt for an ARM, you will need to ask yourself if you'll be able to manage a higher mortgage payment. And also if it makes sense to take on the risk. Assuming you only plan to stay in the home for five years or less, or refinance before then, a 5/1 ARM would make a lot of sense, but how many people can actually say that?

At the same time, many borrowers refinance or pay off their mortgages long before their full term, so you could argue that there's a chance the adjusted rate won't actually matter. In conclusion, it comes down to your unique situation and what type of borrower you are. If you have a low risk appetite and plan to stay in the home for the foreseeable future, a fixed-rate mortgage is a good choice, especially now since mortgage rates are still historically very low.

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Conversely, if you aren't risk-averse and plan on either refinancing or selling your home in the near future, choosing an ARM might make a lot of sense. The monthly savings could even allow you to save up for a bigger home purchase in the future. Either way, be sure to do your research, draw up a plan, compare rates and outcomes, and shop around before making a decision.

Colin Robertson is the author of several finance websites aimed at helping consumers save money, including The Truth About Mortgage and The Truth About Credit Cards, which includes his popular credit score range.