Fixed Versus Adjustable: Which Mortgage is Best for You?

(ARA) - You've spent months combing real estate ads, countless weekends touring open houses, and days waiting for your offer to be accepted. You're just steps away from your dream home with one hurdle left -- your mortgage. With so many options, you could spend even more precious time trying to choose the right one for you. Most mortgages, however, can be narrowed down to two types: fixed-rate and adjustable-rate.

The Basics

Fixed-rate mortgages - These mortgages are the most common loans used by home buyers. The principal and interest payment on a fixed-rate mortgage is the same for the life of the loan. The most popular terms are 30- and 15-year fixed mortgages. However, there are also 10-, 20- and 40- year options. The shorter the term, generally the lower the interest rate.

Adjustable-rate mortgages (ARMs) - These loans have interest rates and monthly payments that change with the economy. As market interest rates rise or fall, your rate and payment will be adjusted accordingly. There are caps, typically 2 percent a year and a specified lifetime maximum, to limit the total rate increase, so you know ahead of time what the maximum amount you could pay would be.

ARMs are available with adjustment periods of six months, one year, three years or five years. For example, if you have a three-year ARM, your interest rate and monthly payment can change every three years. There are also hybrid ARMs that offer a longer initial fixed period and then begin adjusting every year after that. For example, a 5/1 ARM has a fixed interest rate for the first five years and then adjusts annually.

Is Fixed for You?

Fixed mortgages are a good choice if interest rates are low or if they're expected to rise. You have the security of knowing your interest rate will never change. If the interest rate should go down, you always have the option of refinancing.

Fixed-rate loans are also wise choices for individuals who are on fixed budgets. If you are unsure of your future financial situation or if you don't expect that your income will rise, you know exactly how much to budget for.

Should You Grab an ARM?

Adjustable-rate mortgages can come with initial interest rates one to two points lower than fixed-rate mortgages, which make them ideal for periods when interest rates are high. ARMs also work well for home buyers who plan to be in their homes for a short time. They get the benefit of a lower initial rate and may move before any significant rate increases.

For buyers who are stretching their budgets to get into a more expensive home, the lower rate of an ARM may make it easier to qualify for a larger loan. There are risks involved with ARMs, however, and home buyers should be sure they can afford the payments at their highest level.

Don't forget to shop around. Mortgage rates can vary from one financial institution to the next.

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