Choosing Between a Fixed and Variable Rate Home Mortgage

When you purchase a home for the first time, one of the most important things you will have to figure out is whether a fixed rate or adjustable rate mortgage (ARM) is best for you. First, of course, you need a clear idea of what they are.

Fixed Rate Home Mortgage

To put it simply, the interest rate of a fixed rate home mortgage is unchanging. This interest rate will not change during the entire length of the loan, and will not be affected by changes in others interest rates. Many new buyers decide to go with a fixed rate home mortgage, since these mortgages make it easier to plan for the future. Because the interest rate on your home mortgage never changes, neither do your 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. Though you will always be able to predict your monthly home mortgage payments (except for any property taxes and homeowners insurance), your interest rates will generally be higher than with an adjustable rate mortgage. The reason for the higher rates is that the banks typically take a greater risk on fixed rate mortgages and therefore can charge a premium to lock in a rate for the entire term of the mortgage.

A Home Mortgage with Adjustable Rate Interest

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. During a period of rate adjustment, your home mortgage rates will rise or fall depending on what is happening in the index your rate is connected to. Simply put, if rates go up, your home mortgage payments will go up as well.

In general, a variable rate home mortgage starts with a lower interest rate than a typical 30 year fixed rate mortgage. But if rates go up across the board, your interest rates will rise. 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 plan to stay in your home only a few years, its possible for you to save money by choosing an adjustable rate home mortgage with a lower fixed rate for the first few years of the loan. Youll be out of the house before the rate ever adjusts. If you plan to be in your home longer and dont want to face a rate adjustment, the longer term fixed rate option may be the best fit for you.