The major difference between a set Rate Mortgage and an Adjustable Rate Mortgage is its rate of interest. The rate of interest in a Fixed Rate Mortgage is fixed for the whole repayment term and the rate of interest on a good Adjustable Rate Mortgage is fixed for a small period and is then fluctuating with respect to the current credit rates in the market.
Fixed Rate Home loan
The rate of interest charged in Fixed-Rate mortgage is constant throughout the loan period as well as the amount you pay every month is fixed. This amount consists of the interest rate and the principal amount. The amount you contribute for the interest rate payment changes every month and so does the primary amount. These loans are normally allocated for 30, 20, 15 many years.
Advantages
- The amount to be paid every 30 days is fixed. This helps the debtor to plan their expenses and budgeting.
- Fixed rate mortgages also protects the debtor against the fluctuation in the interest rates as the interest rate is constant throughout the repayment period.
Disadvantages
- If the interest rate goes down in the future; you still end up paying a higher interest rate.
- The monthly paid amounts are usually high.
- The interest rate charged are usually high as, you are paying a price to protect yourself against the future hike in the interest rate for over a period of 15-30 years.
Adjustable Price Mortgage
In case of adjustable-rate mortgages, the rate of interest on the loan changes over some time. The rate of interest charged in the initial period is fixed after which the rate increases with time. The period in which the interest rate remains constant is fixed; but the period in which one can pay a fixed interest rate varies from institutions to institution. The repayment amounts you'd pay each month would be different. The rate of interest on adjustable rate mortgage is dependant on the index rate or the prime lending rate. The fixed rate mortgage period lies between 10 months to 10 years and the loan period can move up to 30 years.
The most commonly used indexes in america are:
In case of adjustable-rate mortgages, the rate of interest on the loan changes over some time. The rate of interest charged in the initial period is fixed after which the rate increases with time. The period in which the interest rate remains constant is fixed; but the period in which one can pay a fixed interest rate varies from institutions to institution. The repayment amounts you'd pay each month would be different. The rate of interest on adjustable rate mortgage is dependant on the index rate or the prime lending rate. The fixed rate mortgage period lies between 10 months to 10 years and the loan period can move up to 30 years.
The most commonly used indexes in america are:
- Cost of Funds Index
- London Interbank Provided Rate
- 12 Month Treasury Index
- Bank Expenses Swap Rate
- National Average Contract Mortgage Rate
- Continuous Maturity Treasury
There are three ways of applying the index to the interest rate.
1. Directly
Under this way of determining the interest rate, the interest rate changes as per the changes within the index. Normally, the contract rate index is applied straight.
2. On a Rate + Margin
In this situation, the rate of interest will be specified as index along with a margin.
For example: The rate of interest would end up being specified as MTA (Month Treasury Average Index) + 1%. This 1% may be the margin.
3. Indexed Movement
In this way of using index rate, a rate on the mortgage is fixed and is then adjustable with respect to the movement of the index. Here the rate of interest isn't tied to the index but the adjustments in the actual index are.
Advantages
1. One main advantage in considering the Adjustable Rate mortgage would be benefiting from the lowering interest rate.
2. Another advantage is that, the initial rate of interest is generally lowered by the bank; considering the risk you tend to be taking, if the rate of interest increases in the near future.
Disadvantages
1. A major disadvantage is that, if the interest rate increases in the future, you end up paying a higher interest rate.
2. You are not protected from the fluctuations in the credit market as your interest rate change accordingly.
Which Loan Should You Opt For?
You are able to Opt for an Adjustable Rate Mortgage if...
1. Directly
Under this way of determining the interest rate, the interest rate changes as per the changes within the index. Normally, the contract rate index is applied straight.
2. On a Rate + Margin
In this situation, the rate of interest will be specified as index along with a margin.
For example: The rate of interest would end up being specified as MTA (Month Treasury Average Index) + 1%. This 1% may be the margin.
3. Indexed Movement
In this way of using index rate, a rate on the mortgage is fixed and is then adjustable with respect to the movement of the index. Here the rate of interest isn't tied to the index but the adjustments in the actual index are.
Advantages
1. One main advantage in considering the Adjustable Rate mortgage would be benefiting from the lowering interest rate.
2. Another advantage is that, the initial rate of interest is generally lowered by the bank; considering the risk you tend to be taking, if the rate of interest increases in the near future.
Disadvantages
1. A major disadvantage is that, if the interest rate increases in the future, you end up paying a higher interest rate.
2. You are not protected from the fluctuations in the credit market as your interest rate change accordingly.
Which Loan Should You Opt For?
You are able to Opt for an Adjustable Rate Mortgage if...
- You are prepared to take the risk of increase in the rate associated with interest.
- You are looking at the lower interest rate charged in the initial period of the loan.
- If you're okay with the changing annual payments.
- If you don't qualify for higher rate loan programs, then this is actually a good option.
You can Opt for a Fixed Price Mortgage if...
- You are willing to protect yourself against the increase in the interest rate in future.
- If you are looking at a set repayment amount and period.
Before opting for an Adjustable rate mortgage or a fixed rate mortgage you will have to thoroughly asses the following factors.
- Amount and amount of the loan
- Current economic conditions
- Future financial changes
- How much are you willing to pay every month?
- Are you looking at stability in terms of payments or are you searching at benefiting from the changes in the market problems?
Ask your self the above mentioned points and calculate the chance cost of buying a Fixed Rate Mortgage or Flexible Rate Mortgage and also compare the mortgage companies you plan to buy your mortgage from. All this would assist you in making the correct choice.