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Advantages and Disadvantages of Fixed and ARM Mortgages

Advantages--Fixed

Advantages--ARM
  • Since you know what your payment will be for the life of the loan, you can budget more easily.
  • Lower initial interest rate and therefore lower monthly payment.
  • No possibility of an interest rate change making your mortgage payment suddenly unaffordable.
  • If interest rate declines, your payment will also decline.
  • No anxiety over interest rate fluctuations.
  • Easier to qualify for due to lower initial interest rate and payment amount.

Disadvantages--Fixed

Disadvantages--ARM
  • More income needed to qualify because of higher initial mortgage rate.
  • If interest rate increases, your payment will also increase.
  • If interest rates decrease appreciably, it will be necessary to refinance to get a lower payment.
  • A large increase in interest rates--and payment--could make your house unaffordable.

Each ARM has four basic components:

  • INTEREST RATE - usually one to three percentage points lower than that of most fixed-rate mortgages. Lower initial interest rates may also make ARMs somewhat easier to qualify for. The initial interest rate is tied to certain economic indicators that dictate in part what the monthly payment will be.
  • ADJUSTMENT INTERVAL - the time between changes in the interest rate and/or monthly payment; typically one, three or five years, depending on the index used.
  • INDEX - the figure against which Lenders measure the difference between what they are making on their investment in the mortgage and what they could be making on other types of investments. The most commonly used index on the East coast is based on the rate of return on a one year Treasury bill (T-bill). The most commonly used index on the West coast is based on the 11th District cost of funds (COFI).
  • MARGIN - the additional amount the Lender adds to the index to establish the adjusted interest rate on an ARM. The margin is usually 2.5% to 3%.

Some ARMs have fixed-rate conversion options. This option allows the Borrower to make his variable rate loan become a fixed-rate loan. There is usually a fee required for the conversion. The conversion rate may be higher than the prevailing fixed rate to compensate the Lender for the risk it takes in regard to market rates going up.

Lenders who offer ARMs must give a disclosure about the ARM program at the time the applicant completes an application form and pays a nonrefundable fee.

 

 

 

All images and text © Copyright J Slemmer 2000, 2001, 2002, 2003, 2004, 2005, 2006, 2007, 2008, 2009
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