Understanding An Adjustable Rate Mortgage
Among the options you have when choosing a mortgage loan, there are those of a fixed or adjustable interest rate. While the fixed rate is easy to understand – the same interest throughout the life of the loan, it could be a good idea to have a closer look at how an adjustable-rate mortgage works.
As the name suggests, the interest rate of such a mortgage loan does not remain the same until the loan is paid off in full. Instead, it will be recalculated after an initial period which can vary from one lender to another.
In order to know how long the loan will operate at a fixed rate, you should check the two numbers usually accompanying the loan offer. The lender will normally propose something in the form of 5:1, 1:1, or 3:2. These are, of course, not the only possibilities, just the most common. The first of these two numbers will tell you how many years the rate will remain unchanged before the interest rate is reviewed for the first time. The second number represents the interval at which the following reviews will take place. Thus, in the case of the first two numbers in our example, we are dealing with a mortgage whose interest rate will not change during the first five years, after which it will be reviewed and changed every year.
When opting for either a fixed or an adjustable-rate mortgage, you should be aware of the benefits and risks involved in each type. For that, you should also be familiar with the current market situation and the expected trends. As far as fixed-rate mortgages are concerned, there are not many predictions necessary: the rate will simply not change. If, however, you choose an adjustable-rate mortgage, you should have reasons to believe that the rate will not change in a way that is unfavorable to you. In the next paragraphs, we shall further discuss the advantages and disadvantages of adjustable-rate mortgage loans.
The number one advantage of an adjustable-rate mortgage is that the rate at which it is offered is normally below that of a fixed-rate mortgage. Since the lender is free to change the rate after an agreed period, they can afford to offer you the most attractive rate for now. If you don’t plan to hold the mortgage for more than a few years, it could be a smart choice to take advantage of the low rate and choose the adjustable type.
If the interest rates on the market are currently high, an adjustable-rate mortgage can again be an attractive choice. That is because the rate can be changed after a while when the market comes back down. On the contrary, with a fixed-rate mortgage, you would have to keep paying that high interest for the whole duration of the loan.
But if everything could only change for the benefit of the borrower, lenders would stop offering this kind of mortgage. There are also chances that the interest rate will go up, and so will your monthly payments.
Therefore, if you’re willing to take risks, or if you have reasons to believe that the interest rate will decrease in time, you should go for an adjustable-rate mortgage. If, however, you feel more comfortable knowing that the interest you must pay will remain constant, then you should choose the other option.
