Pros And Cons Of Adjustable Rate Mortgages Versus Fixed Rate Mortgages

Fixed Rate Versus Adjustable Rate Mortgages

Gustan Cho Associates

Most mortgage loan programs, whether it is FHA insured mortgage loans or conventional mortgage loan programs offer adjustable rate mortgages and fixed rate mortgages.  There are pros and cons of adjustable rate mortgages versus fixed rate mortgages and there are advantages and disadvantages of these types of programs depending on the mortgage loan borrower and their needs.  Factors like how long a homeowner is intending on staying in the home and how often the homeowner is intending in refinancing play vital factors in choosing adjustable rate mortgages versus fixed rate mortgages.

What Are Fixed Rate Mortgages

Fixed rate mortgages are by far the most popular mortgage loan program most home buyers and refinance mortgage loan borrowers choose.  Fixed rate mortgages are mortgage loans that have fixed rates for the term and life or the mortgage 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 mortgage loan.  Whether interests sky rocket or plummet, it does not affect the mortgage loan borrower.  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% mortgage rate loan to a new 2.75% mortgage rate mortgage loan.  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, and 10 year fixed rate mortgages.  Will all fixed rate mortgages, once the term of the mortgage loan is up, the mortgage loan has been paid in full.  Monthly payments on fixed rate mortgage loans, the monthly payments are inversely proportionate with the term of the mortgage loan.  The longer the term of the mortgage loan, the lower its monthly mortgage payment it is.  The shorter the term of the mortgage loan, the higher its monthly mortgage payment it is because with the shorter term mortgage loan, the homeowner is repaying the mortgage lender the balance of the loan over a shorter period of time.  Shorter term fixed rate mortgages normally have lower interest rates because the mortgage lender has a shorter term liability on mortgage rates.  Also, with shorter term mortgage loans, you will save thousands of dollars in interest because you are paying the balance of the mortgage loan in a shorter period of time.

Adjustable Rate Mortgages Versus Fixed Rate Mortgages

Adjustable rate mortgages is also referred to an ARM. Adjustable rate mortgages, ARM, differs from fixed rate mortgages where the interest rates can change over the term of the mortgage loan.  One great advantage of adjustable rate mortgages versus fixed rate mortgages is that the interest rates of adjustable rate mortgages are substantially lower than fixed rate mortgages.  The reason why adjustable rate mortgages interest rates are much lower is because the mortgage lender is not obligate to guarantee a certain interest rate for the life of the mortgage loan.  Mortgage lenders only have to guarantee a certain interest rate for the fixed rate period and after the fixed rate period is over, then the new interest rates adjusts based on the index rate.  This reduces the risk factor for the mortgage lender.

How Do Adjustable Rate Mortgages Work?

With adjustable rate mortgages, the mortgage interest rates are fixed for a certain period of time and after that period is over, the mortgage interest rates with adjust every year for the term of the mortgage loan and the new adjustment is based on the index, which changes depending on the type of index, plus the margin, which is constant for the term of the loan.  For example, say that you get a 5/1 ARM with a starter rate of 3.0%, margin of 3%. based on the COST MATURITY TREASURIES ( CMT, one year treasuries ).  With this adjustable rate mortgage loan program, your interest rate will be 3.0% for the first five years of your mortgage loan.  After the fifth year, you new mortgage interest rate will adjust.  If the CMT , index, is 2.0%, your 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%, then your new interest rate will be the 1.0% index plus the 3.0% margin or 4%.  Your interest rate will adjust every year until the term of the loan.

Adjustable Rate Mortgages Or Fixed Rate Mortgages?  Which Should I Choose?

Depending on your long term goals, adjustable rate mortgages may or may not be the best choice for you.  If you plan on purchase a home and living there for a long term, then a fixed rate mortgage may be the best option for you since you have security with the fixed rate mortgage rate.  However, if you are a first time home buyer and are planning in moving in the next five years or so, then you can greatly benefit by choosing an adjustable rate mortgage loan program versus a fixed rate mortgage loan and take advantage of the lower interest rate.  If you are planning on purchasing with a FHA loan because you may have bad credit or higher debt to income ratios and are planning on refinancing your FHA loan to a conventional loan in the next year or too to avoid the costly FHA mortgage insurance premium, you may want to choose an adjustable rate mortgage versus a fixed rate mortgage.

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The information contained on Gustan Cho Associates website is for informational purposes only and is not an advertisement for products offered by The Gustan Cho Team @ Gustan Cho Associates or its affiliates. The views and opinions expressed herein are those of the author and/or guest writers of Gustan Cho Associates Mortgage & Real Estate Information Resource Center website and do not reflect the policy of Gustan Cho Associates Lenders Network, its officers, subsidiaries, parent, or affiliates.

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