Fixed and Adjustable Mortgages

Fixed Rate Mortgage Loans

A fixed rate mortgage, as its name implies, features a rate of interest that stays "fixed" over the term of the loan.

From a budgeting prospective, a fixed rate mortgage will give you a steady and predictable monthly payment. It also offers you protection against rising interest rates and market fluctuations. If you plan to stay in your home for a long time, a fixed rate mortgage may be your best option.

Features and Benefits

Fixed rate mortgages offer the following features and benefits:

  • The interest rate and payment never changes for the life of your loan
  • If your needs change or interest rates drop significantly, most fixed rate loan programs allow you the option to refinance - without a prepayment penalty. Check with your lender for details on pre-payment restrictions.
  • Fixed rate terms can match your repayment goals: 10-, 15-, 20-, 25-, and 30 year terms are available.

Adjustable Rate Mortgages (ARMs)

With an adjustable rate mortgage (ARM), the interest rate you pay is adjusted from time to time as market rates change. Your adjustment could be daily, monthly, every six months, or more commonly once a year. This means as the market rates adjust, your monthly mortgage payment may go up or down.

ARMs are an attractive means of financing because of their initial "below market" interest rate. That is, the starting rates on most ARMs are below current fixed rate levels. And because ARM payments start off lower than fixed rate mortgage loans you may qualify for a larger loan amount.

You may consider an ARM if you plan to move in a few years and therefore are not as concerned about possible rate increases. Or if you are confident that your income will rise enough in the coming years to comfortably handle any increases in payments.

The amount your payment may increase or decrease will depend on the "annual" and "lifetime" interest rate caps. The caps, which set a maximum periodic and lifetime adjustment of your mortgage payment, are pre-set at the closing of your mortgage loan. Before applying for any ARM product, make sure you are comfortable with the maximum mortgage payment.

It is also important to know what index you ARM will be adjusted against. A common index is the United States One-Year T-Bill (T-Bill) or London Interbank Offer Rate (LIBOR).

Fixed Rate / Adjustable Combinations

Combined fixed/adjustable rate mortgage products can provide you with the best of both mortgages. Your interest rate will be fixed for an agreed upon term and then adjust thereafter. For example, a 5/1 ARM loan will give you 5 years at a fixed rate, adjusting yearly thereafter for the remaining 25 years on a 30 year loan. With a fixed/adjustable combination mortgage you receive the benefit of knowing exactly what your payment will be monthly and the "below market" advantage of an adjustable loan. The most common fixed/adjustable mortgages are: 3/1-, 5/1-,7/1-, and 10/1 options.

Whether to select a fixed, adjustable, or combination ARM depends on many factors.  You should have a detailed conversation about all the options available to you with your lending partner.

This information provided courtesy of My Way Home member, American United Mortgage Corporation.