Fixed
Rate vs. Adjustable Rate
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 ARMs.
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
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.
ARM 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
ARM 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
