Fixed
Rate vs. Adjustable Rate
Fixed Rate Mortgages
A Fixed-Rate Mortgage applies the same interest
rate toward monthly loan payments for the life
of the loan. Fixed-rate mortgages are more straightforward
and easier to understand than Adjustable Rate
Mortgages (ARMs), are also more secure for the
buyer, and are popular with first-time homebuyers.
Since the risk to the lender is higher, fixed-rate
mortgages generally have higher interest rates
than Adjustable Rate Mortgages.
For example, a lender can offer a 30-year fixed
loan to a homebuyer at a 7.0% interest rate. The
loan is locked in to the 7.0% interest rate, even
if the market interest rate rises to 9.0%. Conversely,
if the market interest rate decreases to 5.5%,
you, as the borrower, will continue to pay the
7% interest rate.
Fixed-Rate benefits include:
- No change in monthly principal and interest
payments regardless of fluctuations in interest
rates
- More stability may give you "peace-of-mind"
Fixed-Rate disadvantages include:
- Higher initial monthly payments compared to
those of adjustable rate mortgages
- Less flexibility
Adjustable Rate Mortgages
An Adjustable Rate Mortgage is a variable or
flexible rate mortgage with an interest rate that
varies according to the financial index it is
based upon. To limit the borrower's risk, the
Adjustable Rate Mortgagemay have a payment or
rate cap. An Adjustable Rate Mortgage (ARM) does
not apply the same interest rate toward monthly
payments for the life of the loan. Throughout
the life of that loan, the homebuyer's principal
and interest payment will adjust periodically
based on fluctuations in the interest rate.
For example, a lender could offer a 30-year ARM
loan to a homebuyer at an initial 6.5% interest
rate. During an adjustment period for the ARM
loan, the market interest rate could rise to 8.0%,
resulting in a significantly larger interest payment.
Similarly, the market interest rate could decrease
to 6.0%, resulting in lower interest payments.
Adjustable Rate Mortgages benefits include:
- Initial payments lower due to lower beginning
interest rate, usually about 2 percentage points
below the fixed rate
- Ability to qualify for a higher loan amount
due to lower initial interest rates
- Lower interest payments if the interest rate
drops over time
- Interest rate caps limit the maximum interest
payment allowed for the loan
Adjustable Rate Mortgages disadvantages include:
- Initial lower interest rate and monthly payments
are temporary and apply to the first adjustment
period. Typically, the interest rate will rise
after the initial adjustment period.
- Higher interest payments if the interest rate
rises over time
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