Fixed vs adjustable loan rates

Posted: 02/09/2007--25/11/2008 || Rate this Article: 3 || Views|| Sign In || Register ||Hello Guest

When you purchase a home and get a loan you will need to pay interest to the bank. Interest is the amount of money you pay the bank to borrow their money to buy your home. The interest rate can be different depending on which type of loan you get. There are two main types of loans, a fixed rate loan or an adjustable rate loan. If you think about what each type of loan is called it is pretty explanatory, but it helps to understand how each one works. There is a big difference between an adjustable rate mortgage and a fixed mortgage in how much your payment will be. The difference could mean being able to afford a home or not.

An adjustable rate mortgage is also known as an ARM. The interest rate is usually lower to start with than a fixed rate loan and therefore many people who previously could not afford it will be able to either get a home or get into a larger home. If it benefits you to have a smaller loan payment in the beginning because you know your income will go up in a year or two, it may make sense to get an adjustable rate mortgage. Adjustable rate loans are a good starter loan for some new home buyers. The interest rate is determined by what the U.S. Treasury Bill is or another government indicator. The beginning interest rate is usually 2 or 3 percentage points lower than a fixed rate mortgage and it can go up or down depending upon if the U.S. Treasury Bill goes up or down. The percentage interest rate is sometimes referred to as the points below the indicator or margin. The interest rate will adjust on this type of loan usually once a year, so potentially your payment could go up or down once a year depending upon the national interest rate. Study the loan documents and ask the right questions to protect yourself and make sure it is a good financial decision to get this type of loan.

There are several things you will need to pay attention to when considering an adjustable rate mortgage. The starting interest rate of the loan should be low enough to make sense to get into this type of loan. Will interest rates be going up sharply in the future? None of us has a crystal ball, but if interest rates are already extremely low, then the only place they can go is up. Getting an adjustable rate mortgage when rates are already low is not advisable. You also need to ask how often the loan will adjust; once a month, once a year, once every three years. The most common adjustment schedule is every 6 months or once a year. Make sure you can afford to pay a high payment every six months or year. Find out how many interest rate points it can go up or down with each adjustment. Usually there is a limit on the fluctuation, meaning it can only go up 1 percentage point a year. Find out what the cap is or the stopping point on how many total points the interest rate can go up. The cap is required by law to protect the consumer from a loan that gets higher and higher if the economy takes a turn for the worse. Find out what market rate or margin the interest rate is tied to. For example, the interest rate could be tied to the U.S. Treasury Bill or it could be tied to another indicator that fluctuates considerably more. Some of the other indicators that can determine your interest rates are the Federal Cost of Funds, the 11 District Cost of Funds or a T-Bill. You want the interest rate tied to a conservative indicator so your rate will stay stable. Ask your lender to figure out and write down what will happen to your house payment each time the rate could go up. You should always assume that the payment will go up and then if it goes down it will be a bonus. An adjustable rate loan is kind of like gambling on the future. If interest rates go up it could mean a higher house payment, if interest rates go down you will have a lower house payment.

A fixed rate mortgage begins with the interest rate that is common in the market place at the time you lock in your interest rate or complete your loan. Sometimes your interest rate can be higher than the market standard if you have bad credit or are a high risk. The interest that you start with will always stay the same. If interest rates go up you will be lucky to have a low interest rate. However, if interest rates go down you will be stuck with a high interest rate or refinancing your loan which will cost time and money. You still need to do your research if you get a fixed rate mortgage to make sure you are getting the most competitive interest rate you can get. Check to make sure you are not paying high loan origination fees. Also make sure there are no prepayment penalties on paying off your loan.

There are also loans available that are a combination of a fixed rate loan and an adjustable rate mortgage. The way they work is, the interest rate starts a little bit lower than a fixed rate and stays fixed for three, five, or maybe even ten years. After this time the loan turns into an adjustable rate mortgage and can go up a set amount if the interest rates have gone up during that time, or they could go down if interest rates have gone down. Another type of combination fixed rate and adjustable rate loan is one where it allows you to switch over to either type anytime during the loan if you should want to.

Both types of loans have their negative and positive attributes. You need to do the research and educate yourself so you will know which best suits your needs at the time of purchases. If you need to get into a house now and you are strapped for cash the only way you may qualify for the house is with an adjustable rate loan. Just make sure you can afford the payment should it increase.