Home Loan Rates - ARM or Fixed?

This article defines the characteristics of and differences between the two major types of a home loan rates. It also discusses some of the advantages and disadvantages of each.

There are many ways to structure home loan rates, but the two most common type of loan structures are the Fixed Rate Mortgage and the Adjustable Rate Mortgage. The type of mortgage rate that you choose will depend upon your own situation.  The interest rate is the amount the loan costs you over time and varies according to the initial rate set or according to the changes in the index rate applied to your loan.  The fixed rate loan will carry the same interest rate throughout the life of the loan, while the ARM changes according to a predetermined index rate.

Definitions

There are two major types of mortgage loans.  Home loan rate that is set at the beginning of the loan and doesn't change during the course of the loan is known as a fixed rate loan, for obvious reasons. The loan rate is often based on what the economy is doing at the time.  Lenders want to protect themselves if there is an indication that loan rates may change drastically during the course of the loan. 

The adjustable rate mortgage is flexible and helps to protect the lender in situations where the interest rates are rising over a period of time.  If the increased in rates reach a certain level, the lender is allowed to adjust the interest rate and thus the payment amount upward for the balance of the loan term

ARM Advantages and Disadvantages

The ARM is relatively new on the home loan rates picture.  The ARM or adjustable rate mortgage was created at a time when fixed mortgage rates were high.  The ARM allowed initial interest rates to be set lower than the prevailing fixed rates and to be adjusted upward according to a predetermined formula in the future.  For example, the ARM might be set with the rate two points lower than the fixed mortgage rates at the time with the provision that after two years, the rate would be adjusted in accordance with a predetermined index in the future. More borrowers could qualify to obtain the loan, while the lenders didn't have increased risk so long as the interest rates or index were increasing.

Fixed Rate Advantages and Disadvantages

Fixed rates are often set slightly higher than ARMs in order to lock in a loan rate when rates are rising so that the lender doesn't lose money on the opportunity to lend money at higher interest rates.  At the same time, with a fixed rate, if the rates are falling, the lender has the older fixed rate loans that are bringing more interest money than the current loan.  Fixed rate type home loan rates packages are believed to be more favorable to the borrower than the lender.

Another advantage of the fixed rate loan is structure.  You can not be priced out of your home by increasingly painful mortgage rate adjustments with corresponding payment amount adjustments.  This makes it easier to budget and to plan your expenditures over a longer period of time.

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