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Whether it be buying a home or taking out a home equity loan, it can be both an exciting and a confusing experience when faced with mortgage decisions; there are so many things to consider when it comes to applying for and accepting the loan offered to you. One of the options that you will find coming up is the choice between a fixed rate mortgage and an adjustable rate mortgage.
In recent months there has been a rather large amount of media attention focused on mortgage rates and their effect on the economic downturn that has affected banks and consumers on a global scale.
As a mortgage shopper, you may not have a choice in the type of mortgage rate that is offered to you. The type of mortgage and the interest rate offered to you can vary greatly; depending on how your credit history shapes up, the size of your down payment, your debt to income ratio, and several other factors.
Adjustable Rate Mortgages
An adjustable rate mortgage (ARM) is a mortgage, either a primary or home equity loan, where the interest rate, and by effect the monthly payment, will periodically change based upon several deciding factors.
An ARM will, in general, be locked into a fixed rate for a determined amount of time; this can be anywhere from one to five years.
During this time period your rate will not budge; regardless of the situation in the interest rate market.
Rates on an ARM are, often, set far lower than those of a fixed rate mortgage; this can greatly benefit the mortgage borrower. For one thing, it allows the borrower to have a significantly lower payment for the “locked rate” term. During this time the borrower can take the opportunity to increase their monthly income; allowing for sufficient funds when the interest rate increases.
Very often, homeowners who do not intend on remaining on the property and plan to resell the house at the end of the locked-rate term will select an ARM; simply because it allows them to have a lower payment during the time that they do live in the house.
This, in turn, will allow them to qualify for a larger loan and a larger home.
At the end of the fixed rate term (also known as the adjustment period), homeowners have the option to convert their mortgage into a fixed rate mortgage. However, this plan can backfire on the homeowner; any negative change in your credit standing can disqualify you for a decent fixed interest rate.
Oftentimes ARM’s are offered to homebuyers with less than stellar credit histories or a lower income than that which is required to qualify for the mortgage. This type of mortgage lending can, unfortunately, lead to homeowners losing their homes when they cannot afford the raise in monthly mortgage payments.
Fixed Rate Mortgages
A fixed rate mortgage (FRM) is the most popular amongst mortgages offered to homebuyers. With your FRM your interest rate is locked into the percentage rate given to you at closing for the entire life of the loan. Unlike an ARM, the monthly repayments with the FRM will never fluctuate as a result of the interest rate changing.
This can be of great benefit for a homeowner since they have the reassurance that their monthly mortgage repayment amount is going stay within the affordable range they have already agreed upon with the mortgage company. The rate on the fixed rate mortgage is, in general, going to be higher than one offered on an adjustable rate mortgage; again, however, that interest rate is fixed and will never change for the life of the loan. There is a fair amount of security to the homeowner with the knowledge that their interest rate will not change and thereby put them at risk of losing their house simply because the new monthly payment amount is beyond what they can pay.
In short, there is a mortgage that is right for you. You simply need to carefully evaluate your credit standing, your income, and your plans for the next few years.
If you believe that your credit history might be affected in the next few years then it is probably not a very wise decision to opt for an adjustable rate mortgage. If you are confident that your credit standing will not change and you do not plan on staying in the home for longer than the locked in term of the mortgage, then perhaps the adjustable rate mortgage is the right choice for you.