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The Difference: Fixed and Adjustable Rate Mortgages

Whether you are planning to purchase your first home, or you have purchased before and it’s time to move to a new home, it’s important to understand the different types of mortgage loans available. One of the most important things about your new loan (that will play a key role in your total monthly payments) is the interest rate. You may have heard about “fixed rate” or “adjustable rate” mortgages, which both offer advantages and disadvantages, but if you’re not sure what the difference is between the two, read on to find out.

Fixed Rate Mortgage

When you have a fixed rate mortgage, the interest rate on your loan will never change as long as you have the loan. It is set from the time that you sign the papers to close on your new home, and doesn’t fluctuate regardless of what happens with market interest rates. This type of loan is advantageous because you know your rates and payments will remain constant, and having this kind of stable payment helps you budget and plan better. They are also straightforward and easy to understand so you don’t get any surprises.

The disadvantage is that if interest rates do go down and you want to take advantage of it with a lower payment you will need to refinance, which can mean additional closing costs and paperwork. The initial interest will also be higher (and thus your monthly payments higher) than an adjustable rate would be, so it can be expensive for some homebuyers who might be able to afford higher payments later but cannot do it from the outset of the loan.

Adjustable Rate Mortgages (ARM)

Adjustable rate loans, also called ARMs, generally start at a lower interest rate for a set period of time, then can fluctuate up or down depending on the market. The interest rate of your loan is tied to a broad measure of interest rates (called an “index”), and when that index goes up, so does your payment amount. In some cases your payment might also go down with the index, but not in all cases so it’s important to understand the terms of your loan in advance.

The advantage of this type of loan is that the interest rate often begins very low, which can make it an affordable option for many homeowners. These lower payments can also help you qualify for a better home when you initially take out the loan. If your loan is structured to allow for the interest rates to go down with the index, you can take advantage of falling rates without the added closing costs. Plus they offer a lower-cost option for homeowners who are not planning to stay in a specific home for long.

The opportunity to see your payments go down with interest rates also means that they could go up with rising rates. Some ARMs have limits on how high your rate can go, and how often it can be adjusted, but there are cases where you might see the interest rate double or more over the life of the loan. Higher interest rates mean higher house payments, so it’s important to figure out how high the rates could go and still allow you to make your monthly mortgage payments. Finally, since there are many intricacies to these loans, a novice homebuyer could get confused or even trapped by an unscrupulous mortgage company.

It’s important for homeowners to understand all the parts of these two types of loans so you can choose the one that makes the most financial sense for you. Talk to a mortgage loan office today to find out more.

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