Sunday, September 30, 2007

Fixed Rate vs. Adjustable Rate Mortgages

With all the loan options out there, choosing the right loan for your needs can be an extremely daunting task. Not only do you have fixed rate and adjustable rate mortgages (ARMs) to choose from, but you can also vary the length of your loan. With all these different options, what’s the best for you?

Unfortunately, there is not a single mortgage product that works for everyone. However, the upside of having options is that you can select the right mortgage plan that fits your particular needs. Each type of mortgage has its benefits and downsides. When used correctly, you can maximize the benefits of a particular mortgage type.

A fixed rate mortgage is exactly what it sounds like – the interest rate of the loan is locked at a single rate for the life of the loan, which can be from 15 to 50 years. The most common options for fixed rate mortgages are 15, 30, 40, and 50 years. Fixed rate mortgages are good if your risk tolerance is extremely low, you are able to lock in a low interest rate, interest rates are likely on the rise over the long term, and you do not plan to sell the home for 5 – 10 year or longer. Once you decide a fixed rate mortgage is right for you, selecting the term of the mortgage can be tricky. The quicker you are able to pay off the loan, the less interest you will pay. However, shorter loan periods will result in larger monthly payments. When selecting the length of the loan, it’s important to figure out how much you can afford each month. Even though a 50 year loan may seem enticing, bear in mind the interest charges you will pay over the life of the loan. Also, if interest rates drop during the loan period, you can always refinance to lock in lower rates or even switch to an adjustable rate mortgage product.

Unlike a fixed rate mortgage, an adjustable rate mortgage (ARM) interest rates vary over the life of the loan. The most common ARM terms are 1, 5, 7, and 10 years. ARMs have a fixed interest rate for a specified period of time, after which the interest rate adjusts based on market conditions and may increase or decrease. Because there is more risk associated with the interest rate variability, adjustable rate mortgages typically have lower interest rates during the fixed period. Typically, the shorter the term of the loan, the lower the interest rate is during the fixed period. After this fixed period, the interest rate will fluctuate monthly. Adjustable rate mortgages are good if you have a higher risk tolerance, if the fixed portion of the loan has a much lower interest rate compared with a fixed rate mortgage, and if you do not plan to stay in the home for more than 5 to 7 years. If interest rates drop, you can refinance your loan to lock in even lower rates. When used correctly, ARMs can save thousands of dollars when compared to fixed rate mortgages.

With any loan, it’s important you know how much you can afford each month. Once you understand your own particular situation, selecting the right loan product will be much easier.

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