Adjustable Rate Mortgage Vs Fixed Rate Mortgage - Which One to
you look at the different home loan programs that are available to individuals who are purchasing a home of
planning on a mortgage refinance, you will see that they generally fall into two groups. The first is the Adjustable Rate Mortgage (ARM) and the next is a Fixed Rate
Mortgage. By understanding a little more about both types of
mortgages, you will be able to decide which one is for you.
The ARM is often called
a variable rate mortgage because the rate being charged for the loan adjusts over the course of the
loan. Many are designed to stay at a certain rate for a period of
time before they adjust. The ARM is tied to a specific index in the
credit market and margin. The margin stays constant and the index
can fluctuate daily. The rate will adjust depending on which index
the lender has tied the loan to. Common indices that ARMs are tied
to are the London Interbank Offered Rate (LIBOR), the Cost of Funds Index (COFI), and the Treasury Bill
(T-BILL). An ARM may adjust several times before its final
adjustment to a fixed rate for the remainder of its term.
index the loan you are looking at is tied to will help you know whether your rate will adjust more
often. Some of the indices are more volatile than
others. You will find that there are lenders who prefer the LIBOR
index because it has a higher margin that the others do and the bank can make more money because the margin is
the constant part of the rate. However, an ARM that is tied to the
LIBOR means an increase in payment for the homeowner because it historically adjusts upwards. Many of the sup-prime and bad credit mortgage ARMs in the early 2000s were tied to this
However, not every ARM
will adjust upwards every time it adjusts. The COFI index is not as volatile and has even adjusted to a lower
rate rather than upwards. This type of adjustment can be very
helpful to the homeowner.
The main advantage of an
ARM is that it usually starts out much lower than a fixed rate mortgage does. A lower rate means a lower payment for the homeowner, at least until the rate
adjusts. This allows some added flexibility at the beginning of the
loan. A fixed rate loan is fully amortized, which means that both
the amounts going to the principal and the interest are the same for the duration of the loan, which may give
some security in knowing that the payment will never go up, whether you are purchasing a home or doing mortgage refinancing.