Fixed or Adjustable?
That is the Interest(ing)
Question
Before adjustable-rate mortgages came into being, only fixed-rate
mortgages existed. Usually issued for 15- or 30-year periods, fixed-rate mortgages
(as the name suggests) have interest rates that are fixed (unchanging) during the
entire life of the loan.
With a fixed-rate mortgage, the interest rate stays the same and
your monthly mortgage payment amount does not change. No surprises, no uncertainty, and no
anxiety for you over interest-rate changes and changes in your monthly payment. Your
mortgage interest rate and monthly payment remain locked for the life of the loan. If you
like the predictability of your favorite television show airing at the same time daily,
you'll probably like fixed-rate mortgages.
Here are a couple of other possible minor drawbacks to be aware
of with some fixed-rate mortgages:
- If you sell your house before paying off your fixed-rate mortgage,
your buyers probably won't be able to assume that mortgage.
- Fixed-rate mortgages sometimes have prepayment penalties
(explained in the nearby sidebar). The ability to pass your loan on to the next buyer (in
real estate talk, the next buyer assumes your loan) can be useful if you're forced
to sell during a rare period of ultra-high interest rates, such as occurred in the early
1980s. Selling during such a time could reduce the pool of potential buyers for your home
if, in order to avoid a prepayment penalty, you don't allow an otherwise-qualified buyer
who is having trouble obtaining an affordable loan to assume your mortgage.
On the other hand, adjustable-rate mortgages (ARMs for
short) have an interest rate that varies (or adjusts). The interest rate on an ARM
typically adjusts every six to twelve months, but it may change as frequently as every
month.
Although some adjustables are more volatile than others, all are
similar in that they fluctuate (or float) with the market level of interest rates.
If the interest rate fluctuates, then so does your monthly payment. And therein lies the
risk: Because a mortgage payment is likely to be a big monthly expense for you, an
adjustable-rate mortgage that is adjusting upwards may wreak havoc with your budget.
Given all the trials, tribulations, and challenges of life as we
know it, you may rightfully ask, "Why would anyone choose to accept an
adjustable-rate mortgage?" Well, people who are stretching themselves -- such as some
first-time buyers or those trading up to a more expensive home -- may
financially force themselves into accepting adjustable-rate mortgages. Because an ARM
starts out at a lower interest rate, such a mortgage enables you to qualify to borrow
more. As we discuss in Chapter 2, just because you can qualify to borrow more
doesn't mean that you can afford to borrow that much, given your other financial
goals and needs.
If you like change -- you enjoy trying different foods and
getting up at a different time each day -- you may think that adjustable-rate mortgages
sound good. Change is what makes life interesting, you say. Please read on, because, even
if you believe that variety is the spice of life, you may not like the financial variety
and spice of adjustables!
This Homebuyers Tip was excerpted from
Home Buying For Dummies, by Eric Tyson, Ray Brown. © 1997 by
Eric Tyson, Ray Brown, used by permission of IDG Books.
ISBN#: 1568843852
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