Fixed Rate Vs Adjustable Rate Mortgages

What is a Fixed-Rate Mortgage? The interest rate on a fixed-rate mortgage remains the same throughout the entire loan term, allowing you to make periodic (usually monthly) payments of the interest and the entire principal spread over 15 to 30 years. The payment amounts remain the same.

Fixed Rate Vs Adjustable Rate Mortgages

What is a Fixed-Rate Mortgage?

The interest rate on a fixed-rate mortgage remains the same throughout the entire loan term, allowing you to make periodic (usually monthly) payments of the interest and the entire principal spread over 15 to 30 years. The payment amounts remain the same. Only a change in taxes or insurance (if included in the loan) could change the amount of the payments. Short-term-fixed-rate mortgages usually have a lower interest rate than long-term loans because the lender risks the cost of funds rising above the rate of returns while locked into a long-term loan.

What is an Adjustable-Rate Mortgage?

An adjustable-rate mortgage (ARM) is one in which the interest rate can increase or decrease periodically, meaning your monthly payment may also increase or decrease. The calculate the ARM interest rate, lenders add a few percentage points called the "margin" to the "index." Most ARMs adjust the interest rate and monthly payment every One, Three, or Five years, called the "Adjustment Period." Many ARMs limit (cap) the percentage of interest increase/decrease at each adjustment period, while some cap the increase percentage in the monthly payment adjustments. Some cap neither the interest nor payment adjustments. Therefore it is extremely important to understand what changes will occur during an ARM loan term.

Be Cautious of "Discount" Offers

Lenders sometimes offer "discount" or "teaser" interest rates in order to attract borrowers to ARMs. These rates could be for a specified period, such as six months or a year. A cap on interest increase could allow a borrower to have a below-market interest rate for several years. However, it is possible for interest rates to rise to the loan cap, which would significantly increase monthly payments. Therefore, it is important to ask for all of the information the lender has on the loan you're considering to avoid surprises down the road.

Deciding Factors

When deciding on a mortgage loan type, it's helpful to know your short and long-term plans/goals for the property, and consider your financial situation, as there are advantages and drawbacks for both fixed and adjustable-rate mortgage loans. While fixed-rate loans offer the confidence of knowing your payment will never increase, long-term loans will likely have a higher interest rate. ARMs are risky in that it's difficult to predict increased interest rates, yet over the long-term, they may end up saving you money due to various interest rate decreases. To be sure you make the decision that's right for you, be sure to ask your potential lender to fully explain the loan terms to you, and if you the answers are unclear, ask until they are.

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