Home Mortgage Help: Fixed and Variable Rates

02/03/09

When buying your home, one of the first big decisions you'll have to make is whether to go for a fixed rate or an adjustable rate mortgage (ARM). Before knowing which is best for you, however, you need to be aware of how each one works.

Fixed Rate Home Mortgage

A fixed rate mortgage has an interest rate that does not change. This interest rate will not change during the entire length of the loan, and will not be affected by changes in others' interest rates. Oftentimes, new buyers decide to use a fixed rate home mortgage, as this kind of loan is easier to plan for in the long term. As the interest rates you are paying on your home mortgage are always the same, so are your mortgage payments. For example, if you take on a $175,000 home mortgage with a fixed rate of 6.5% for 30 years, your payments will be $1106 throughout the length of the fixed rate loan (without escrow costs).

There are upsides and downsides to going with a fixed rated home mortgage. While you will always be able to depend on a fixed mortgage payment (excluding property tax and insurance), you will typically have a higher interest rate than if you used an ARM. This is because banks are generally taking on more risk with fixed rate loans, and so charge you more for keeping a frozen rate for the duration of your home mortgage.

Adjustable Rate Home Mortgage

An adjustable rate home mortgage is often called a floating rate, as your rate changes along with interest rate indexes. Normally, this kind of home mortgage will start off with a fixed rate for a predetermined amount of time (generally three to ten years). After that time, the rate will adjust at predetermined intervals. At these adjustment periods the rate you pay will rise and fall along with whatever index your rate is tied to. To put it simply: if interest rates go down, your payment will go down also.

Normally, an adjustable home mortgage rate will start off lower than a comparable fixed rate for a 30 year mortgage. But if interest rates go up, your payments will go up. Fortunately, many adjustable rate home mortgages come designed with a rate cap, which will limit the number of percentage points your rates can go up.

The most important part of deciding on the best loan for you is having a thorough understanding of your acceptance of risk, as well as a plan for the amount of time you will own the home. If you will only be in your home for a few years, you could save money by taking advantage of an adjustable rate mortgage that has a low fixed introductory rate for 3 to 5 years. Chances are, you will have left the house before your rates ever change. If you plan to stay in your home a long time and do not want to deal with changing interest rates, a fixed rate option might be best for you.

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