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Everybody knows that a fixed rate has advantages over an adjustable rate under certain circumstances but they also know that generally adjustable rates tend to be lower than fixed rates. Thus, it gets a bit complicated to decide whether to apply for a mortgage with a fixed or variable rate. In order to make up your mind you need to fully understand both rate types and their consequences.

In the loan process one of the most crucial decisions and usually the most difficult as well, is whether to opt for a fixed rate mortgage or adjustable rate mortgage. Adjustable-rate mortgages (ARMs) prove to be highly tempting for homebuyers but they come with a high degree of uncertainty. Rates may rise again, which is the reason why over 75 percent of homeowners choose to go for a fixed-rate mortgage.

Interest Rate Is The Key Factor

In fixed mortgage rate, a firm interest rate is offered for a predetermined loan amount. The rate remains constant throughout the life of the loan and therefore so does the monthly payments until the loan has been repaid. For a fixed loan the rate charged is typically higher than that of an adjustable mortgage rate. Fixed mortgages are generally for large purchases.

In the case of adjustable rate mortgages, the rate may change over time due to the interest rate going either up or down. Adjustable rate mortgages are bound to several indexes, usually published. The amount added by a lender to the index is the margin, usually two or four percentage points, in order to set the actual interest of the adjustable rate mortgages. Rate charges mostly peak at 2 percentage points annually and a maximum of 6 percent over the duration of the loan.

30 Years or 15 Years?

Lenders mostly offer various options for mortgages with the most common being the fixed-rate mortgage for 30 or 15 years. 30 year fixed rate mortgage is an industry standard as total payments are spread over many years to make your monthly payments lower than in the case of a shorter-term loan. The interest rate is set or locked in at the time of getting the mortgage and stays constants through the life of the loan.

A 30 year loan can cost thousands of dollars more in interest than a shorter term debt but since the interest is 100 percent tax deductible, after tax cost is significantly. However 15 year fixed rate mortgage is increasingly becoming common as the borrowers pay a lower interest rate in return for larger monthly payments. A 15 year fixed rate mortgage gives you an interest rate typically one quarter to one half percent lower than a 30 year fixed rate mortgage. The shorter the term is, the lower the interest rate. But the main advantage is the huge interest savings you make during the life of the loan.

How About Adjustable Rate Mortgages?

The initial adjustable mortgage rate tends to be lower than the fixed mortgage rate. Following the initial fixed period, adjustable rate mortgages mostly adjust on each anniversary of the mortgage. Some adjustable rate mortgages adjust every three years based on yields on three-year treasury securities. The new rate is actually set about 45 days before the anniversary, based on the index at the time. If your plan to be in the house or less than five years, it's better to take the lower adjustable rate mortgages, particularly if rate adjustments happen only every three years. However, if you are planning to stay for many years, adjustable mortgages may be a huge risk.

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