Fixed rate loans have a stated interest rate that does not change over the life of the loan, whereas the rates on adjustable rate loans are linked to an index and change as the index rate changes. Many mortgages, such as a 5-Year Fixed (30 Year), start as a fixed rate loan and then convert to an adjustable rate. Adjustable rate loans have more risk due to the possibility that the interest rate could increase. However, because you are assuming some of the risk the lender will generally reward you with a lower interest rate. These loans are best for borrowers who do not plan on keeping the loan for the full term.
Fixed ARMs typically offer low rate for a fixed period of time.
- If you are planning to refinance or move within the fixed period of time, then a fixed ARM might be a good choice.
- The Fixed ARM will typically let you buy more home at a lower monthly payment.
- Adjustable Rate Mortgages (ARMs) can be nailed down for 1 month, 6 months, 1, 3, 5, 7, or 10 years.
Disadvantages
- Your payments are lower with ARMs and will stay low unless interest rates skyrocket. If interest rates go up the lender will adjust your ARM upward by a maximum of 2% points a year with a maximum of 6% over the complete loan period.
How Adjustable Rate Mortgages computed?
- Typically, a lender will use a lower rate for the first year to get you in the door.
During the 2 nd year, the lender will start tying the rate to a financial Index such as Treasury Bills of the 11 th District Cost of Funds. The lender will add a margin (make sure to ask what the margin is!) to arrive at your ARM rate for the new adjustment period.
