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
