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The Difference Between Fixed And Adjustable Mortgage Loans

Many home buyers are tempted to get the 30-year fixed rate mortgage. However, you can get a lower interest rate with an adjustable rate mortgage. The fixed rate mortgage loan provides security but is more expensive while the interest rate on the adjustable mortgage may fluctuate.

Let us try to lay it all out on the table and see what is a good fit for you.

Most ARM’s (Adjustable Rate Mortgage) come with an initial fixed rate and adjust every year on the anniversary of the mortgage.

The Difference Between Fixed And Adjustable Mortgage Loans

The rate is set 45 days in advance of the anniversary based on an index and some adjust every month. If this is very uncertain for you, you’re better off with a fixed rate mortgage.

If you’re planning on staying in the house only for a few years, go for the adjustable rate as it has a lower interest rate and your payments will be lower. This will allow you to save for a bigger place.

Look at the market conditions. If the market interest rates are higher, ARM’s allow you a lower rate initially. If the rates are falling, there’s a good chance you’ll get a better deal on the payments. If the rates are low, it might be better to get into a fixed rate mortgage.

If interest rates rise considerably on the ARM’s then you could be in bind with your monthly payments going up as well. In this scenario, the fixed rate mortgage is the obvious choice.

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Let’s take a closer look at some of the terms in an ARM:

Adjustment frequency: This is the amount of time elapsed between an adjustment in the interest rate i.e. monthly or yearly.
Adjustment indexes: The interest rate could be the same as a certain index plus a margin. These indexes could be the Cost of Funds index or on the basis of Treasury Bills.
Margins: This is the percentage over and above the adjustment index.
Caps: These refer to caps or limits on the adjustable interest rates or on the monthly payments.

Let us look at the advantages of a fixed rate mortgage:

These are simpler to understand than ARM’s that come with many different variables that might stymie the first time buyer.
They have a fixed rate and are helpful in budgeting, these don’t give any sudden shocks or jolts.
Rates remain stable despite prevailing market conditions.

Let us look at some of the drawbacks of fixed rate mortgages compared to ARM’s:

It can get expensive because there are no interest breaks early on or changes in the interest rate even if the market interest rates are lower.
If market interest rates lower, borrowers will need to refinance to reap those benefits which includes closing costs and a great deal of paperwork.
ARM’s allow lenders to customize the loan for the borrower while fixed rate mortgages are identical from one lender to another.

There is a need for research to be done, thus, don’t go for the ARM just because it lets you get your house with smaller monthly payments. Instead shop around and find a good deal for yourself.

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