The type of mortgage you take out can make a great difference to you.



Paper or plastic? Car or SUV? Rent or buy? Perhaps one of the biggest decisions you will ever make is whether to take a fixed-rate or adjustable rate mortgage.

So what exactly is the difference between these two types of mortgages? With a fixed rate mortgage, your payments are the same for the life of the loan.

Regardless of inflation or other economic factors, your mortgage payment will never change. Many people choose a fixed rate mortgage because of the stability it offers.

With an adjustable rate mortgage, ARM, your payments will vary depending on the interest rate. Lenders favor this type of mortgage because the interest rate of the mortgage changes based on other economic factors.

Even with ARMs, there is an initial period in which the interest rate is fixed. After that period the interest rate will adjust a periodic basis, usually annually.

In nearly all cases, the initial principal and interest payments on an adjustable rate mortgage are lower than that of a fixed rate mortgage. This is the aspect of the ARM that leads many homebuyers to choose this type of mortgage over the alternative.

If you can get a lower monthly payment with an ARM for as many as ten years, then the ARM is the best choice, right?

Not necessarily. Before you decide to choose the Arm based solely on the initial monthly payments, consider the future.

There is a good chance that interest rates could increase once the initial fixed period of the ARM expires.

If this happens will you be able to afford the monthly payments on the loan? Of course, this depends on your current job, the length of time you plan to remain at that job, and the likelihood of raises in the future. Many people's homes end up in foreclosure because they were unable to make their mortgage payments when interest rates increased. You should assess the risk of this happening to you before choosing one type of mortgage or the other.

How long do you plan to remain in the home? If it is less than five years, then an adjustable rate mortgage is the best choice. Overall you will end up paying less with an ARM in that period of time than you would if you chose a fixed rate mortgage. On the other hand, if you intend to remain in the home more than five years, a fixed rate mortgage is definitely worth considering.

The benefit of a fixed rate mortgage comes with the fact that the payments are fixed over the life of the loan. Because of this, there are never any surprise interest rate increases; you always know how much you are going to pay. The stable mortgage payments make it easier for you to budget from one year to the next.

On the other hand, higher incomes are generally needed to qualify for a fixed rate mortgage because the interest rate is higher. The lender needs to be sure you can afford the payments. Not only that, if, in the future, interest rates decrease significantly, you will have to refinance to avoid overpaying for your home.

Understanding the benefits and the drawbacks of each type of loan is the best way to make the best decision for you.