A lot of decisions go into buying a home and one of the most important decisions you will need to make is whether you would prefer a Fixed Rate Mortgage or an adjustable rate mortgage (ARM). Either can have their advantages and either can have their disadvantages as well, depending upon your situation and personal preferences.
Fixed Rate Mortgage:
Interest rates for Fixed Rate Mortgages are preset at the time of the signing of the loan. The amount of the loan and interest are figured into the total amount of the loan and divided by the term length of the loan.
With a Fixed Rate Mortgage, you do not have to worry when interest rates increase as your interest rates are locked in for the duration of the loan. If the interest rates rise, this works towards your advantage as you will still be paying your mortgage with the lower rates that were locked in.
Another benefit is the option to choose between a fifteen or thirty year term loan. With a fifteen year term, your equity will grow quicker because you will be paying off the loan at a faster pace. However, with less time to pay off your loan your monthly payments will be much higher.
If you opt for the 30-year loan you can always send additional money toward the principal at any time. If you were to do this every month your loan would, of course, be paid off sooner than 30 years.
Fixed Rate Mortgages usually cost more initially than adjustable rate mortgages. This is due to the fact that Fixed Rate Mortgages are higher risk for lenders as the rate is fixed and they could be losing out on higher interest rates depending upon the market.
Even though ‘fixed’ rate sounds as though whatever your monthly mortgage payment is now that is what it will always be for the duration of the loan, this is not entirely true. During the length of the loan, you may be putting a certain amount of funds into an escrow account each month to cover property taxes and home owner’s insurance. If either of these rates go up, so will your monthly mortgage payments.
You may also find yourself trapped into paying at a higher interest rate if the rates drop below your fixed rate. You will always be able to refinance at the current rate, but remember that this will require paying loan fees again.
Adjustable Rate Mortgage (ARM):
Adjustable rate mortgages adjust and fluctuate throughout the term of your loan. Since they are not fixed, the rate may adjust up or down depending on the prime rate.
An adjustable rate mortgage will cost less initially because you, as the borrower, are taking the risk of the rate increasing throughout the term of the loan. However, if the interest rates should drop, so will your monthly payments.
There are Caps placed on ARMs so that your interest rate can never go above a certain percent.
Just as your monthly mortgage payments can be lowered when interest rates fall, so can they be raised when interest rates climb. Many homeowners have been unprepared for climbing interest rates and have had to sell their homes when the prime rate fluctuates.
The choice between a fixed rate loan and an adjustable rate mortgages is a personal decision that needs to be considered carefully. Depending upon your financial situation, either type of home loan can work to your benefit. Knowing about these loans and your situation will go a long way towards protecting your home and your credit.