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Fixed vs Arm Rate

Generally speaking, you can break mortgage loans down a number of ways: type of loan, transaction type, is it a federal loan, payment terms, amortization schedule, etc.   One of those ways is whether or not the loan has a fixed vs arm rate. This is by far one of the more important aspects to consider when pursuing a home loan, regardless of whether it is a purchase or a refinance.

This is a question of security and longevity.  Do you want a rate that is fixed and stays the same for the life of the loan, or one that will potentially change on you?  This is a key question.

A fixed rate loan is what it sounds like – a loan with an interest rate that is fixed for the life of the loan.  This means that no matter what, no matter what happens in the financial marketplace, your rate will not change.  You do not have to worry about your mortgage interest rate going up.  But of course, this also means that it won’t ever go down.  This allows you to plan for your future, budget farther out, etc.  It is a matter of security, having the peace of mind that comes with knowing exactly what your interest rate will be for the life of the loan. *Please note:  This does not mean that your total mortgage payment won’t ever change.  Changes in your property taxes or insurance premiums could affect your escrow payments (if you are escrow), and this could cause your overall payment to change.

An ARM, short for Adjustable Rate Mortgage, is the opposite.  This is a rate that can, and more than likely will change as the markets fluctuate.  Now, one interesting factor with these loans is that they often do have a set period of time during which the rate is, in fact, fixed.  Typically, you see these in odd number increments:  1 year, 3 years, 5 years, 7 years and then there might be a 10 year option.  During the specified time, the interest rate will not change. Once that time has elapsed, however, the rate will become adjustable, varying based on the market conditions at that time.  Most commonly these rates are adjusted based on the LIBOR index, but some may be different depending on your lender.  And while the rate in theory could go down (which would be great), it is much more likely that the rate will increase once it hits the adjustable period.  It all depends on the state of the markets at that time.

It is worth noting that these loans sometimes have pre-payment penalties associated with them.  Which prepayment penalties are fewer and even more rare these days, but they do exist still in some cases.  Typically, if there is a prepayment penalty, it may coincide with whatever fixed term is applied to your ARM loan.  For example, if you have a three year ARM, then your rate is fixed for three years, but you may get hit with a penalty if you pay off your current loan before that three years is up.  It is important to be very aware of the terms of your loan, including prepayment penalties, when working with your mortgage advisor.

The one bright point for ARM home loans is that their rates are often less than fixed rate loans, at least on the front end.  For example, if you were to look at market rates today, it is almost a sure bet that interest rates on a three year ARM will be lower than rates on a fixed 30 year loan.  The kicker, of course, is what happens when the loan goes adjustable – and no one can predict this!

Most people who opt for an adjustable rate mortgage rather than a fixed rate mortgage do so assuming that they will be able to refinance into a fixed rate loan within a few years, or before their fixed period expires.  This can yield some hefty savings, but can also cause problems down the road.  The recent housing bubble crisis was affected, in part, by ARM loans.  People assumed the housing markets would stay the same or get better, making them quite confident that they would be able to refinance out of their ARM loans before their rates went up.  When the housing market faltered and home prices declined, homeowners found themselves owing more than their homes were now worth, which made it all but impossible to refinance.  Now stuck in their current loans, they were subjected, in many cases, to increased interest rates once their loans went adjustable.  This, of course, led to higher mortgage payments that they could not afford, and the rest, as they say, is history.

The key is understanding the risks involved with ARM loans, as well as the potential benefits.  If you’re putting a larger down payment on your home, and will have a larger amount of equity, this may limit your risk, as you’ll have a better chance to refinance out of an ARM when the time comes.  But it is still never a guarantee, and risk is involved.  Most people these days, especially in light of the recent housing crisis, opt for the fixed rate loan.  This way you’re set – nothing is going to change.  Lower rates on the adjustable rate mortgage loans are tempting, but there is something to be said for knowing your rate will never go up on you.

If you would like to talk with a mortgage professional about your home loan options, fill out the form to the right to get started on our application, and we’ll get you in touch with someone who can help!

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