The Differences Between Fixed & Adjustable Loans
Banks offer a wide range of loans that cover anything from a small personal loan up to a mortgage on a home. Two common types of loans include fixed and adjustable loans. Banks tell borrowers up front about what kind of loan they are receiving and payment terms. Signed contracts contain the agreed-upon fees and conditions. Understanding all terms and conditions of the loan applied for will save the borrower headaches and confusion down the road.
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Fixed Rate Loan
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A fixed rate loan keeps the same interest rate throughout the entire pay-off period. Loans for a car repair up to a car or home purchase use fixed rate loans. According to AdvantageHomeRate, borrowers often consider fixed rate loans when interest rates drop to lower percentages. Once the lower interest rate secures for the loan, the borrower continues to pay this rate until the loan is paid off. The borrower does not worry through the life of the loan that payments may change.
Adjustable-Rate Loan
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An adjustable-rate loan contains an interest rate that varies throughout the lifetime of the loan. Banks often grab the interest of the borrower by offering a low affordable interest rate and increasing the percentage over time. According to the Federal Reserve Board, a common misconception of an adjustable-rate loan includes the idea that rates go up when interest rates go up. A bank may raise payments on the loan at any time. Some banks actually charge a penalty fee for borrowers that pay the loan off early.
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Functions
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LoanSafe.org points out that adjustable-rate loans were initially implemented for borrowers with poor credit scores and little chance for a fixed-rate loan. Today consumers choose either type of loan for different reasons or needs. The Digital Federal Credit Union suggests three considerations for every borrower when choosing the right loan. The buyer should determine whether an initial low interest rate or a payment that remains the same for the loan life is more important. If the borrower is securing a loan for a home, he should see what the typical mortgage rate looks like at the time the loan is initiated versus what predictions are for upcoming mortgage rates. Finally, the borrower should consider how long the loan will last or how long the borrower plans to live in the home.
Warnings
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Carefully read all loan documents before signing any contracts. Ask questions of the loan officer if the expectations or loan agreements are confusing. All terms of the loan including interest rates and fees are required in writing. Check for loan margins, caps or ceilings. Ask the lender about any fees or penalties. If the lender uses terms that are unclear to the borrower, ask for clarification. If the borrower is unsure of what type of loan to choose, ask the lender to fill out a loan worksheet to compare differences.
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References
- Trustingov.org: The Difference Between Fixed-Rate...
- Loansafe.org: What's the difference between a fixed and adjustable rate mortgage?
- AdvantageHomeRates: Compare Fixed and Adjustable Rate (ARM) Home Financing
- The Federal Reserve Board: Consumer Handbook on Adjustable-Rate Mortgages
- Digital Federal Credit Union: Adjustable Rate Mortgages
