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Adjustable Rate Mortgage Vs Fixed Rate Mortgage - Which One to Chose  

As 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. 


Understanding which 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 index. 

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