Fixed vs. Adjustable Mortgage Rates

By Richard Barrington
NFNS Columnist

One of the most fundamental questions a mortgage shopper will face is whether to opt for fixed or adjustable mortgage rates. The right answer depends a great deal on your individual situation, including such factors as how long you intend to own the house and how closely you budget your monthly expenses.

ARMs Take the Heat

Adjustable-rate mortgages have taken some of the heat for the recent mortgage crisis, as some borrowers experienced "sticker shock" when monthly payments adjusted upward. Even so, there is still a place for adjustable-rate mortgages, as long as they are properly understood. In most cases though, a fixed-rate mortgage is likely to make the most sense -- especially under current mortgage rate conditions.

General Guidelines

With a fixed-rate mortgage, your mortgage rate will be locked in for the life of the loan. This means that your monthly payments will stay the same throughout. In contrast, adjustable-rate mortgages feature a variable mortgage rate. Typically, this variation involves two stages: first, there is often a special low "teaser" rate for an initial period lasting from anywhere between 3 months and ten years; second, the mortgage rate will adjust periodically with the financial markets as interest rates go up and down.

Since mortgage rates can change a great deal, an adjustable-rate mortgage could cause significant increases or decreases in monthly payments. That's not necessarily a bad thing -- if interest rates are high when the mortgage is initiated, the opportunity to see them fall without having to pay refinancing costs may be beneficial.

In general though, an adjustable-rate mortgage would be preferable only if one or both of the following conditions were met:

  • You don't plan to own the house for more than a few years. In this case, you can take maximum advantage of a low teaser rate on the front end of the mortgage, without exposing yourself to as many years of interest rate variation on the back end.
  • You have a substantial amount of cushion in your monthly budget. Consequently, an increase in monthly payment will not bring you to the brink of default.

Today's Conditions

Today's mortgage rate conditions add even more weight in favor of fixed rate mortgages. Mortgage rates have recently fallen below 6.0%; historically, mortgage rates have averaged below 6.0% in only three of the past thirty-six years. This suggests that current mortgage rates are toward the lower end of their range. In other words, based on historical levels, rates have more probability of moving upward from here than downward.

The Refinancing Option

Even with a fixed-rate mortgage, it is possible to take advantage of a sharp fall in mortgage rates by refinancing. However, mortgages these days often have refinancing or pre-payment penalties, so check out these terms before you commit.

Ultimately, fixed and adjustable-rate mortgages are just financial tools, and tools themselves are neither good nor bad. Understanding the best way to use these tools will allow you to make them work for you.

Freddie Mac

About the Author:
Richard Barrington is a freelance writer and novelist who previously spent over twenty years as an investment industry executive.

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