The two main types of mortgages are fixed-rate mortgages and adjustable-rate mortgages (ARM). One of the first decision to be taken when seeking a mortgage is to decide which of these types is most appropriate for you.
Fixed-Rate Mortgages
The rate of interest charged on a fixed-rate mortgage remains the same for the lifetime of the loan. The amount of mortgage payment remains the same every month although the principal and interest portions of the payment will vary.
There is one major advantage in a fixed-rate mortgage. If interest rates go up, the borrower will not suffer from any increases in monthly payments of the loan. Furthermore, fixed-rate mortgages are easy to understand and there is little difference in them among most lenders. On the other hand if interest rates are high, fixed-rate mortgages become more expensive and difficult to qualify for.
While the rate of interest is fixed, the total amount of interest paid on the mortgage will depend on the term. Fixed-rate mortgages are most often available for durations of 30, 20, and 15 years from traditional lenders. The thirty-year mortgage term results in the lowest monthly payment and is therefore the most popular with consumers. However, due to the longer duration of the mortgage, the amount that is paid against the interest is greater, resulting in a higher over-all mortgage cost. On a shorter-term loan, monthly payments are higher but the amount paid against the principal is greater, thus the mortgage can be paid off more quickly with substantial savings to the borrower. As well, the interest rates charged on shorter-term mortgages tend to be lower, resulting in further savings to the consumer over the life of the mortgage.
Adjustable-Rate Mortgages
Adjustable-rate mortgages have interest rates that vary during the life-time of the loan. At first, the interest rate is set at a lower level than that of a fixed-rate loan for the same amount - it then increases with time. If held until paid off, the rate on an adjustable-rate mortgage will exceed that of a fix-rate loan.
The first interest rate for an ARM is constant during a fixed primary period; after that it increases at a pre-determined schedule. The initial fixed-rate period may be as short as one month or as long as ten years. The shorter the adjustment period, the lower the first interest rate set for these types of loans.
ARMs offer low initial interest rates and enable the borrower to qualify for a larger loan. However there are downsides to an adjustable rate mortgage. With an ARM, your monthly payments can escalate and if held to maturity you will be paying a rate that’s higher than with a fixed-rate mortgage.
How Do I Choose the Right Loan?
A number of personal and market factors have to be evaluated before you decide. You should consider your future financial prospects, the direction of interest rates in the near-term, how long you plan on holding the mortgage and even the overall strength of the economy.
The answers to the following might help in your decision:
- How much of a monthly mortgage payment can you currently carry?
- Can you still afford an ARM if interest rates were to rise?
- How long do you plan on living in the house you are financing?
- What do you think the trend in interest rates are?
An ARM will not commit you to current interest rates, so if rates are expected to decline in the future, an ARM will give you the benefit of those lower rates. Rates with an ARM will increase with the life of the mortgage, but if you think your financial state will improve in the future, or if you don’t plan on owning the house for long, those higher rates may not be a concern. On the other hand, if there is uncertainty in the direction of interest rates, a fixed-rate mortgage will protect you from future interest rate increases and give you the assurance of fixed monthly payments for the life of the mortgage.
|
SECTION
Featured Articles
