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A Fixed-Rate Mortgage or Fixed Rate Loan applies the same interest rate toward monthly loan payments for the life of the loan. Fixed-Rate Loans are more straightforward and easier to understand than Adjustable Rate Mortgages (ARMs) or ARM mortgages. They are also more secure for the buyer, and are popular with first-time homebuyers looking for home mortgage loans. Since the lender takes a higher risk, fixed-rate mortgages generally have higher interest rates than ARM mortgages. For example, a lender of home mortgage loans can offer a 30-year fixed rate loan to a homebuyer at a 7.0% interest rate. The fixed rate loan is locked in to the 7.0% interest rate, even if the market interest rate rises to 9.0%. Conversely, if the market interest rate decreases to 5.5% for home mortgage loans, you, as the borrower, will continue to pay the 7% interest rate.
Fixed-Rate Loan benefits include:
No change in monthly principal and interest payments regardless of fluctuations in interest rates
More stability may give you “peace-of-mind”
Fixed-Rate Loan disadvantages include:
Higher initial monthly payments compared to those of adjustable rate mortgages
An adjustable rate mortgage, which may qualify as a second mortgage loan, does not apply the same interest rate toward monthly payments for the life of the loan. Throughout the life of that loan, the homebuyer’s principal and interest payment for second mortgage loans will adjust periodically based on fluctuations in the interest rate.
For example, a lender of second mortgage loans could offer a 30-year adjustable rate mortgage loan to a homebuyer at an initial 6.5% interest rate. During an adjustment period for the ARM Mortgage loan, the market interest rate could rise to 8.0, resulting in a significantly larger interest payment. Similarly, the market interest rate could decrease to 6.0%, resulting in lower interest payments.
ARM Mortgage benefits include:
Initial payments lower due to lower beginning interest rate, usually about 2 percentage points below the fixed rate
Ability to qualify for a higher loan amount due to lower initial interest rates
Lower interest payments if the interest rate drops over time
Interest rate caps limit the maximum interest payment allowed for the loan
ARM Mortgage disadvantages include:
Initial lower interest rate and monthly payments are temporary and apply to the first adjustment period. Typically, the interest rate will rise after the initial adjustment period.
Higher interest payments if the interest rate rises over time.
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