Two of the most popular loan types for buying a home or refinancing your mortgage are Fixed Rate & Adjustable Rate Loans.
Fixed-rate loans and adjustable-rate loans are the two primary mortgage loan types. While the marketplace offers numerous varieties within these two categories, the first step when shopping for a mortgage loan is determining which of the two main loan types – the fixed-rate or the adjustable-rate – best suites your needs.
Fixed Rate Loans:
What is a Fixed Rate Loan?
A fixed-rate loan charges a set rate of interest that does not change throughout the life of the loan. Although the amount of principal and interest paid each month varies from payment to payment, the total payment remains the same, which makes budgeting easy for homeowners.
What does a Fixed Rate Loan feature?
- Your interest rate and monthly principal and interest (P&I) payments remain the same for the life of your loan.
- Available in a variety of loan term options.
- You may be able to add extra features such as a temporary buy down.
What are the benefits of a Fixed Rate Loan?
- Predictable monthly P&I payments that allow you to budget more easily.
- Protection from rising interest rates for the life of the loan, no matter how high interest rates go.
- May be a good choice if you plan to stay in your home for a long time.
What are the benefits of a Adjustable Rate Loan?
- Typically Adjustable Rate Loans have a lower initial interest rate than on a fixed-rate mortgage.
- The interest rate cap limits the maximum amount your P&I payment may increase at each interest rate adjustment and over the life of the loan.
- May provide flexibility if you expect future income growth or if you plan to move or refinance within a few years.
Adjustable Rate Loans
What is an Adjustable Rate Loan?
The interest rate for an adjustable-rate mortgage varies over time. The initial interest rate on an Adjustable Rate Loan is set below the market rate on a comparable fixed-rate loan, and then the rate rises as time goes on. If the ARM is held long enough, the interest rate will surpass the going rate for fixed-rate loans.
Adjustable Rate Loans have a fixed period of time during which the initial interest rate remains constant, after which the interest rate adjusts at a pre-arranged frequency. The fixed-rate period can vary significantly – anywhere from one month to 10 years. Shorter adjustment periods generally carry lower initial interest rates.
What does an Adjustable Rate Loan feature?
- Your interest rate and monthly principal and interest (P&I) payments remain the same for an initial period of 5, 7 or 10 years, then adjust annually.
- Loans available in a variety of longer terms.
- Includes an interest rate cap that sets a limit on how high your interest rate can go.
What else should I know about Adjustable Rate Loans?
When it comes to Fixed Rate Loans, monthly principal and interest payments may increase when the interest rate adjusts. Your monthly principal and interest payments may change every year after the initial fixed period is over.
Components of a Monthly Mortgage Payment
Principal & Interest (P&I)
These are two of the main components of your monthly payment on a mortgage or home equity loan. The principal portion of your payment reduces your loan balance. The interest portion is your cost for the use of the principal for that month. If your mortgage loan payments also include property taxes and homeowner’s insurance (and mortgage insurance, if applicable), the monthly payment amount is referred to as PITI (Principal, Interest, Taxes, Insurance).
- An interest-rate cap places a limit on the amount your interest rate can increase. Interest caps come in two versions:
- Periodic caps, which limit the interest-rate increase from one adjustment period to the next
- Lifetime caps, which limit the interest-rate increase over the life of the loan