The most basic distinction between types of mortgages that are
available when you're looking to finance the purchase of a new home is
how the interest rate is determined. Essentially, there are two types
of mortgages - fixed rate mortgage and an adjustable rate mortgage.
If you choose a fixed rate mortgage, the rate of interest that you are
paying on your mortgage remains the same throughout the life of the
loan no matter what general interest rates are doing. In an adjustable
rate mortgage, the interest rate is periodically adjusted according to
an index that rises and falls with the economic times. There are
advantages and disadvantages to either, and no easy answer to 'which is
better, a fixed rate mortgage or an adjustable rate mortgage?
The main advantage to a fixed rate mortgage is stability. Since the
interest rate remains the same over the entire course of the loan, your
monthly payment is predictable. You can count on your monthly mortgage
payment to be the same amount each month. On the minus side, because
the lending institution gives up the chance to raise interest rates if
the general interest rates rise, the interest on a fixed rate mortgage
is likely to be higher than that of an adjustable rate mortgage.
A fixed rate mortgage loan makes the most sense for those that are
going to settle into their home for many years. While the initial
payments may be larger than with an adjustable rate mortgage,
stretching the payments over a longer period of time can minimize the
effect on your budget.
An adjustable rate is one that is adjusted periodically to take into
account the rise or fall of standard interest rates. Generally, the
adjustable term is annual - in other words, once a year the lending
company has the right to adjust the interest rate on your mortgage in
accordance with a chosen index. While adjustable rate mortgages make
the most sense in a situation where interest rates are dropping, though
it's dangerous to count on a continued drop in interest rates.
Lenders often offer adjustable rate mortgages with a very low first
year 'teaser' interest rate. After the first year, though, the interest
rate on your mortgage can increase by leaps and bounds. Even so, there
are limits to how much an adjustable rate can actually adjust. This is
dependent on the index chosen and the terms of the loan to which you
agree. You may accept a loan with a 2.3% one year adjustable rate, for
instance, that becomes a 4.1% adjustable rate mortgage on the first
adjustment period.
Finally, there's a new kind of loan in town. A hybrid between
adjustable rate mortgages and fixed rate mortgages, they're known as
'delayed adjustable' mortgages. Essentially, you lock in a fixed rate
of interest for a number of years - say 3 or 7 or 10. At the end of
that period, the loan becomes a 1 year adjustable rate mortgage
according to terms set out in the agreement you sign with the mortgage
or financial institution.
