Home Finance Guide: Fixed-Rate versus Adjustable-Rate Mortgages

When buying a new home, there are basically two types of mortgages that are available - differing in how the interest rate is determined. These loans are referred to as fixed-rate and adjustable-rate mortgages (ARM).

Fixed-Rate Mortgage - It used to be that only fixed-rate mortgage loans were available. This type of mortgage is usually issued for a 15 - 30 year period, with an unchanging (fixed) rate for the duration of the loan.

Because the interest stays the same with a fixed-rate mortgage, so does your monthly mortgage payment. There are no variables, surprises or changes in the amount you owe each month for your house payment. If you're the type of person that likes predictability and low risk, this type of loan is probably a good choice.

Be aware, that with a fixed-rate mortgage, you'll pay a higher premium (higher interest rate) in exchange for a lender to commit to a fixed rate over a 15 - 30 year period.

The downside to a fixed-rate mortgage is that if rates fall after obtaining your mortgage, you're locked into a higher rate - regardless.

If you don't qualify to refinance, due to a dip in the value of your home or an unexpected decrease in your financial health, you're stuck with your mortgage rate - at least, until the situation changes in your favor.

Adjustable-Rate Mortgage - Unlike the fixed-rate mortgage, an adjustable-rate mortgage (ARMS) has a variable interest rate. Typically, an ARM will adjust every 6 - 12 months - but it can change monthly.

Whatever is happening in overall interest rates will determine the interest rate of an ARM. If there is a rise in interest rates, you will no doubt experience a rise in your ARM - increasing the size of your monthly mortgage payment, on your new home.

So, if you're a person that enjoys a good game of chance, taking risks, and constant change, you may be quite content with an adjustable-rate mortgage.

Hybrid Mortgages - An intermediate ARM or hybrid loan starts out like a fixed-rate loan for 2-10 years and then converts into an ARM. After that point, the rate will adjust about every 6-12 months, but can adjust as frequently as every month.

Balloons Loans - This type of loan looks like a hybrid loan at first glance. A balloon loan has a fixed-interest rate for a period of 5 - 10 years (average). The major difference between a hybrid loan and a balloon loan is that at the end of the fixed-rate period, you are required to payoff the entire balance of the loan.

Folks may choose a balloon loan to get a lower interest rate than that of a fixed-rate mortgage. Make sure that you'll be able to refinance down the road (once the loan balance becomes due), if you're not in a financial position to pay if off completely.

Before making the decision to go with an adjustable-rate mortgage, read my next blog - Home Finance Guide: Rising Interest Rates of an ARM, to find out if this type of loan is right for your financial needs and budget.

For more information on fixed-rate mortgages and adjustable-rate mortgages, check out bankrate.com.