Fixed vs. Adjustable
The Traditional Way to Finance Your Home
It’s easy to understand why the fixed rate mortgage has been the popular choice of homebuyers in America for many years.
Your interest rate remains constant for the length of your loan, so the monthly payments of principal and interest never vary. This makes it easy to budget for a fixed rate mortgage. And it frees you from the uncertainties of the mortgages with fluctuating rates.
Most lenders offer a fixed rate mortgage with terms of 10, 15, 20, 25 and 30 years. The 15 and 30 year are the most popular today.
The shorter the term of the loan, the higher your monthly payments will be. On the other hand, your savings on a loan that matures faster could be substantial. Not to mention the satisfaction of owning your home sooner.
How to Qualify for a More Expensive House
Over the past decade, the Adjustable Rate Mortgage (ARM) has become increasingly popular. Unlike mortgages with a fixed rate, the ARM’s interest rate may rise or fall over the term of the loan.
Typically, an ARM is linked to some economic indicator beyond the Lender’s control, such as the U.S. treasury Security index or the prime interest rate of area banks. As the indicator fluctuates, so will the interest rate of your mortgage.
In order to protect you against unreasonable or rapid increases, most Adjustable Rate Mortgages have interest rate caps and lifetime caps.
A cap limits the increase or decrease allowed during each adjustment period. For instance, a 2% annual cap means your interest rate won’t rise or fall more than 2% in any one year. A lifetime cap limits rate fluctuations over the life of your mortgage. For instance, if the lifetime cap is 6%, that is the most it can be added or subtracted from your initial interest rate over the entire term of your loan.
Generally, the initial rate of an ARM is below that of a fixed rate mortgage. This could qualify you to buy a more expensive home. In any case, under an ARM program, your initial monthly payments are lower than with a fixed rate mortgage.
The Ability to Convert
Some Adjustable Rate Mortgages come with a conversation feature. It enables you to convert an ARM to a fixed rate mortgage if you act within a specific period of time.
The conversation feature is a nice option to have if you believe the future trend will be toward generally rising interest rates. If the trend seems to be toward the falling rates, an ARM lets you benefit from the lower interest rates.
The Most Popular ARM’s
6 month ARM, 1 year ARM, 3 year ARM, 5 year ARM, 7 year ARM, 10 year ARM
The Most Common Indexes can be found in The Wall Street Journal.
- U.S. Treasury Index
- Libor Index (London Interbank Offered Rate)
- 11th District Cost of Funds (based on the Federal Reserve Bank out of San Francisco)
