Adjustable Rate Mortgages Versus Fixed Rate Mortgages


Pros And Cons Of Adjustable Rate Mortgages Versus Fixed Rate Mortgages

Most mortgage loan programs, whether it is FHA, VA, USDA or conventional mortgage programs offer adjustable rate mortgages versus fixed-rate mortgages.

  • There are pros and cons of adjustable-rate mortgages versus fixed rate mortgages
  • There are advantages and disadvantages of these types of programs depending on the borrower and their needs
  • Factors like the following play vital factors in choosing adjustable rate mortgages versus fixed rate mortgages:
    • how long a homeowner is intending on staying in the home
    • how often the homeowner is intending in refinancing

What Are Fixed Rate Mortgages

Fixed rate mortgages are by far the most popular mortgage program. Most mortgage borrowers choose fixed-rate mortgages than adjustable rate mortgages:

  • Fixed rate mortgages are loans that have fixed rates for the term and life of the loan
  • For example, a 30 year fixed rate mortgage loan with a starter mortgage rate of 4.25% has the 4.25% mortgage rate for the life of the 30-year term
  • Whether interests skyrocket or plummet, it does not affect the interest rate on the note
  • They are secured with the 4.25%
  • If the interest rates plummet to 2.75%, the homeowner can choose to refinance their current 4.25% rate loan to a new 2.75% mortgage rate mortgage
  • There are several types of fixed rate mortgages
    • 30 year fixed rate mortgages
    • 25 year fixed rate mortgages
    • 20 year fixed rate mortgages
    • 15 year fixed rate mortgages
    • 10 year fixed rate mortgages
  • Will all fixed-rate mortgages, once the term of the loan is up, the loan has been paid in full
  • The monthly payments are inversely proportionate with the term of the mortgage loan
  • The longer the term of the loan, the lower its monthly mortgage payment it is
  • The shorter the term of the loan, the higher its monthly mortgage payment it is
  • This is because, with the shorter term home loan, the homeowner is repaying the lender the balance of the loan over a shorter period of time
  • Shorter-term fixed rate mortgages normally have lower interest rates
  • This is because the lender has a shorter term liability on mortgage rates
  • Also, with shorter-term home loans, homeowners will save thousands of dollars in interest
  • This because they are paying the balance of the loan in a shorter period of time

Adjustable Rate Mortgages Versus Fixed Rate Mortgages

Adjustable rate mortgages are also referred to an ARM. Adjustable rate mortgages, ARM, differ from fixed-rate mortgages where the interest rates can change over the term of the loan.

  • One great advantage of adjustable rate mortgages versus fixed-rate mortgages is that the interest rates of adjustable rate mortgages are substantially lower
  • The reason why adjustable rate mortgages interest rates are much lower is that the lender is not obligated to guarantee a certain interest rate for the life of a 30-year term loan
  • Lenders only have to guarantee a certain interest rate for the fixed rate period
  • After the fixed rate period is over, then the new interest rates adjust based on the index rate
  • This reduces the risk factor for the  lender

How Do Adjustable Rate Mortgages Work?

With adjustable rate mortgages, interest rates are fixed for a certain period of time. After that period is over, the interest rates with adjust every year for the term of the mortgage loan. The new adjustment is based on the index. The payments changes depending on the type of index, plus the margin, which is constant for the term of the loan.

  • For example, say borrower get a 5/1 ARM with a starter rate of 3.0%
  • The margin of 3%. based on the COST MATURITY TREASURIES ( CMT, one-year treasuries )
  • With this adjustable rate loan program, the interest rate will be 3.0% for the first five years of the loan
  • After the fifth year, your new mortgage interest rate will adjust
  • If the CMT, index, is 2.0%, the new rate will be the index plus the margin, 2.0% index plus the 3.0% margin or 5%
  • Say on year number 7, the INDEX drops to 1.0%
  • The new interest rate will be the 1.0% index plus the 3.0% margin or 4%

The interest rate will adjust every year until the term of the loan.

Pros And Cons On Fixed Versus ARM

Depending on long term goals, adjustable rate mortgages may or may not be the best choice.

  • If planning on purchasing a home and living there for a long term, then a fixed rate mortgage may be the best option
  • This is due to security with the fixed rate mortgage rate
  • However, first time home buyers planning in moving in the next five years or so, they can greatly benefit by choosing an adjustable rate mortgage loan program versus a fixed rate mortgage loan

This is due to taking advantage of lower interest rates ARM offers.

Case Scenario

If planning on purchasing with an FHA loan here is case scenario:

  • due to bad credit or higher debt to income ratios getting FHA Loans initially
  • Planning on refinancing FHA loan to a conventional loan in the next year or two to avoid the costly FHA mortgage insurance premium

Borrowers may want to choose an adjustable rate mortgage versus a fixed rate mortgage.

Related> ARMs

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