Risk or Reliability... A Fixed or Variable Rate Home Mortgage
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by: marciafreeman
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When buying your home, one of the first big decisions youll have to make is whether to go for a fixed rate or an adjustable rate mortgage (ARM). Before knowing which is best for you, however, you need to be aware of how each one works.
A Home Mortgage with Fixed Rate Interest
To put it simply, the interest rate of a fixed rate home mortgage is unchanging. This rate is frozen for the term of the loan, meaning that your rate will stay the same no matter what happens to interest rates over the term of the loan. Oftentimes, new buyers decide to use a fixed rate home mortgage, as this kind of loan is easier to plan for in the long term. Because the interest rate on your home mortgage never changes, neither do your payments. For example, if you take on a $175,000 home mortgage with a fixed rate of 6.5% for 30 years, your payments will be $1106 throughout the length of the fixed rate loan (without escrow costs).
There are upsides and downsides to going with a fixed rated home mortgage. While you will always be able to depend on a fixed mortgage payment (excluding property tax and insurance), you will typically have a higher interest rate than if you used an ARM. This is because banks are generally taking on more risk with fixed rate loans, and so charge you more for keeping a frozen rate for the duration of your home mortgage.
A Home Mortgage with Adjustable Rate Interest
An adjustable rate home mortgage is often called a floating rate, as your rate changes along with interest rate indexes. Normally, this kind of home mortgage will start off with a fixed rate for a predetermined amount of time (generally three to ten years). After that time, the rate will adjust at predetermined intervals. At these adjustment periods the rate you pay will rise and fall along with whatever index your rate is tied to. Simply put, if rates go up, your home mortgage payments will go up as well.
Normally, an adjustable home mortgage rate will start off lower than a comparable fixed rate for a 30 year mortgage. But if interest rates go up, your payments will go up. Fortunately, many adjustable rate home mortgages come designed with a rate cap, which will limit the number of percentage points your rates can go up.
The most important part of deciding on the best loan for you is having a thorough understanding of your acceptance of risk, as well as a plan for the amount of time you will own the home. If you will only be in your home for a few years, you could save money by taking advantage of an adjustable rate mortgage that has a low fixed introductory rate for 3 to 5 years. Chances are, you will have left the house before your rates ever change. If you plan to be in your home longer and dont want to face a rate adjustment, the longer term fixed rate option may be the best fit for you.
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