Fixed Rate vs. Adjustable Rate Mortgages

One of the most important decisions when it comes to taking out a mortgage is choosing between a fixed or adjustable-rate loan.

With a fixed-rate mortgage, the interest rate for your loan is the same on day one as it is on the day you make the last payment, whether that's in 5, 15, 30 years, or more. If you get a fixed rate loan with a 6% interest rate, your interest rate will remain at 6% forever -- unless you decide to refinance.

With an adjustable-rate mortgage, or ARM, your interest rate will change at set intervals during the life of your loan. If you start with a 6% loan, that interest rate can climb to 7%, 8%, 11%, or even higher -- possibly in a few short years. This can represent an increase of hundreds or even thousands of dollars on your monthly mortgage payment, and none of that increase is going toward the principal of the loan, which is the amount of money you actually borrowed.

It is also possible for an ARM to adjust downward, resulting in lower interest rates.

Your lender or broker should be able to help you choose the best loan for your needs. Here are a few of the benefits of fixed rate and adjustable rate loans:

• No surprises: From day one of your mortgage, you know exactly what your payments will be through the life of the loan.
• Low rates are locked in: If you have a fixed-rate loan with a low interest rate, you'll always keep that same low rate. You don't need to worry about rising interest rates affecting your payment.
• Long-term savings: Though the interest rate on a 30 fixed-rate loan can be higher than the starting rate on an ARM, you'll probably save money in the long run. The longer you hold your mortgage, the more sense it makes to lock in at a fixed rate -- assuming that rates are low.

• Low Initial Payments: Most ARMs have an initial period (usually between one and five years) during which their interest rates are significantly lower than fixed rate loans. During this period, your monthly payments will be comparatively low.
• Rates can drop: If you have an ARM and interest rates go down, your monthly payment can drop as well. This can make ARMs especially attractive when interest rates are high, and possibly poised to fall.
• Short term gains: If you're certain that you're going to sell your home within a few years, the low initial rate offered by an ARM can make it a good option. You'll sell before your ARM readjusts to a higher rate, and save thousands of dollars compared to what you would have paid with a fixed-rate loan at a higher interest rate.

If you're still not sure whether a fixed-rate or adjustable-rate mortgage is right for you, you can calculate your payments and compare the results.