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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