Fixed-Rate Mortgage (FRM)
A mortgage whose interest rate is fixed throughout the life
of the loan.Fixed-rate mortgages (FRM) generally have higher interest rates than Adjustable-rate mortgages
(ARM), but the rate never changes.
A FRM term typically ranges from 15-40 years. The longer the term, the lower the monthly
payments will be. The reason the interest rates are higher for FRMs is because you
are paying for the stability of a fixed interest rate.
Benefits of a Fixed Rate Mortgage
A fixed-rate mortgage is not as risky as an ARM and offers stability. FRM are the most common among
first time homebuyers. If a borrower knows they are going to be in the home for the long-term or if they
are unsure of the amount of time they will spend
in the home, it might be wise of them to choose the FRM, just to
be safe. With a FRM, your
monthly
payments will be the same throughout the life of the loan.
You will not have worry about the fluctuating interest
rate an adjustable-rate mortgage
has.
Adjustable-Rate Mortgage (ARM)
A mortgage whose interest rate is not fixed
for the entire life of the loan.
ARMs are advertised with an initial rate, known as the fixed-rate period, and usually
range from 1 to 10 years. After the initial rate, the interest rate is tied to an economic index
that fluctuates.
Key elements of an Adjustable-Rate Mortgage
-
Index
After the fixed interest period of an ARM, the interest rate will increase or decrease
depending
on the index it is tied to, plus the margin that is specified by the lender. The
CMT and LIBOR are examples of common indexes many ARMs are tied to.
-
Adjustment Period
Usually you will see an ARM quoted for example, "3/1", The "3" represents the number of years the loan is fixed. The "1" represents the adjustment period, in this case, once a year. After the initial rate period has ended, the ARM will adjust annually according to the index rate it is tied to. This will cause the interest rate and payments to go up or down.
-
Initial Interest Rate Cap
This is the most your interest rate can increase during the first adjustment period.
If your initial interest rate cap is 4%, your new interest rate cannot be more than
4% of your initial interest rate.
-
Periodic Interest Rate Cap
Sets a cap on the amount your interest rate can change during every adjustment period
after the first period. If your periodic interest rate cap is 2%, your interest rate
cannot change more than 2% after first adjustment period.
-
Lifetime Interest Rate Cap
Sets a cap on the amount your interest rate can increase overall during the entire
life of the loan. If you lifetime cap is 5%, then your interest rate cannot increase
more than 5% over the life of the loan.
The initial interest rates that come with adjustable-rate mortgages are typically
lower than fixed-rate mortgage rates
to be more attractive. Although your interest rate can go up with an ARM, they have their advantages over FRMs.
Benefits of an Adjustable Rate Mortgage
Typically, borrowers choose adjustable-rate mortgages when they plan on holding the property short-term,
allowing them to save on the lower interest rate of the ARM vs. the FRM. For example,
if a borrower is planning on selling the
home in 5 years or less, they may select a 5-year ARM, as opposed to a comparable fixed-rate mortgage. The borrower will end up selling the property
before the ARM reaches the adjustment period. During the fixed rate period, the borrower will benefit from
the lower monthly payments of an ARM.
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