Choosing a Loan: FIXED RATE or VARIABLE
Adjustable rate loans are a fairly recent innovation, but they have been gaining steadily in popularity.
Designed to be more reflective of market conditions—both increases and decreases in interest rates—adjustable rate loans present less of a risk for the lender during the lengthy term of a home loan. As a result, many lenders are willing to offer more flexible terms, including lower initial rates of interest, with adjustable rate loans.
Nonetheless, some borrowers still cling very strongly to the idea of fixed rate loans; they are accustomed to a monthly house payment that will not change. Here's how the two loans compare:
Fixed Rate Mortgage
The fixed rate mortgage is a traditional method of financing a home. The interest rate stays the same for the entire term of the loan—usually 15 or 30 years—so the interest and principal portions of your monthly payment remain the same.
Your payments are stable and predictable, but initial interest rates tend to be higher on a fixed rate mortgage than on adjustable rate loans. Many fixed rate mortgages cannot be assumed by a subsequent buyer.
A fixed rate loan may be preferable if you:
- Plan to stay in your home for more than five years.
Think interest rates will rise dramatically while you are in your home.
Don't expect your income to increase significantly.
Don't expect your home to increase significantly in value.
Prefer operating your finances from a fixed budget.
Adjustable Rate Mortgage "Arm"
The interest on an adjustable rate mortgage is linked to a financial index, such as a Treasury security, so your monthly payments can vary up or down, over the life of the loan—usually 25 to 30 years. Some adjustable rate mortgages have a cap in the interest rate increase to protect the borrower.
The lower initial payments on ARM's make it easier for buyers to qualify. Some ARM's may be converted to fixed rate mortgages at specified times, usually within the first five years.
You may want to consider an adjustable rate loan if you:
- Expect that interest rates will trend downwards or stay about the same.
Plan to stay in your home five years or less.
Need "more house" than you can afford with a fixed rate loan.
Need more money than a fixed rate program allows