How to Compare Fixed Rate Mortgages and Adjustable Rate Mortgages

There are many types of mortgages, and the more you know about them before you start, the better. To compare one Adjustable Rate Mortgage with another or with a fixed-rate mortgage, you need to know about indexes, margins, discounts, caps, negative amortization, and convertibility. You need to consider the maximum amount your monthly payment could increase. Most important, you need to compare what might happen to your mortgage costs with your future ability to pay.

FIXED RATE MORTGAGES

In a fixed-rate mortgage, your interest rate stays the same for the term of the mortgage. The main advantage of a fixed-rate mortgage is that you always know exactly how much your mortgage payment will be, and you can plan for it.

Benefits and Advantages:

- Low rates for the full term of your mortgage

- Security of a fixed monthly payment for the life of you loan, regardless of fluctuations in interest rates

- More stability may give you peace-of-mind

Disadvantages

- Higher initial monthly payments compared to those of adjustable rate mortgages

- Less flexibility

ADJUSTABLE RATE MORTGAGE (ARM).

With this kind of mortgage, your interest rate and monthly payments usually start lower than a fixed-rate mortgage. But your rate and payment can change either up or down, as often as once or twice a year. The adjustment is tied to a financial index. Throughout the life of that loan, the principal and interest payment will adjust periodically based on fluctuations in the interest rate.

Benefits and advantages:

- Lower Initial payments due to lower beginning interest 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

Disadvantages

- Your future monthly payment is uncertain.

- Initial lower interest rate and monthly payments are temporary and apply to the first adjustment period. Usually, the interest rate will rise after the initial adjustment period.

- Higher interest payments if the interest rate rises over time

SUMMARY

A Fixed Rate mortgage will offer you the security of knowing that your mortgage interest rate will not change during the term of your fixed rate. The advantage of an Adjustable Rate Mortgage is that you may be able to afford a more expensive home because your initial interest rate will be lower. 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 ARMs. They are more secure for the buyer and they are very popular with first-time home buyers. Since the risk to the lender is higher, fixed-rate mortgages generally have higher interest rates than ARMs. A fixed rate mortgage is ideal for anyone who likes to budget monthly expenses and plans to keep their home for several years.

A more detailed version of this article including a glossary of terms is available at: http://www.us-banks.org/archives/1970

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Copyright © 2005. Chileshe Mwape writes for The US Banks Guide: http://www.us-banks.org/. Find informative articles and news stories about banking and finance.

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