Adjustable vs. Fixed Rate Mortgages

Adjustable-Rate Mortgages
The popularity of adjustable-rate mortgages (ARM) has created a new directory of terms that savvy buyers need to understand before financing their homes with an adjustable rate loan.

THE INDEX  This is the basis in which the interest rate will adjust . (Some move more slowly because they're averages, such as the 11th District Cost of Funds, and these are preferable in a market when interest rates are climbing.  Others move more quickly, such as the six month CD rate or one-year Treasury Bill, and are more attractive when interest rates are falling.)

THE MARGIN  This is the lender's profit, tacked onto the index to create the total interest rate charged.

THE CAP RATE  There are two to be concerned about: the life cap, which  is the maximum amount the interest rate will ever be for the loan, and the annual cap, which is the highest the interest rate can climb each year.

THE POINTS  One point equals one percent of the loan amount.  This is charged by the lender as a loan-origination fee.  Usually, as this goes up, the margin goes down and vice versa.

When shopping for an ARM, become familiar with the index used, the margin, maximum annual payment and interest increases, lifetime "cap" maximum interest rate and see if the ARM is assumable, by a future buyer of your home.

Fixed Rate Mortgages
If you plan to stay in your home less than seven years, an adjustable rate mortgage can save you interest.

If you plan to keep your home over seven years, a fixed-rate mortgage is usually the safest.

Should interest rates plummet, you can refinance.  If interest rates rise, a fixed-rate mortgage protects you because your payment cannot increase.