Where adjustable-rate mortgages have interest rates that rise and fall based on the prime rate, the interest rate on fixed-rate mortgages remains the same for the duration of the mortgage. While a fixed-rate mortgage is safer because it ensures stable mortgage payments, it is not always the ideal choice for all borrowers. This is because fixed-rate mortgages have both advantages and disadvantages.
Advantage: Stable Monthly Payments
When a borrower takes out a fixed-rate mortgage, the lender amortizes the payments on that mortgage. In doing this, the lender is determining the total amount that will be owed on both principal and interest over the course of the loan. That amount is then divided by the number of monthly payments the borrower will make. Because the interest rate will not fluctuate, this amount won't change. Excepting for factors like changes in homeowner's insurance premiums and property tax rates, the monthly mortgage payment on a fixed-rate mortgage remains the same over the life of the loan.
Disadvantage: Higher Interest Rates
One benefit of adjustable-rate mortgages is that they have an initial period in which their interest rate is fixed. This initial fixed interest rate is usually lower than the interest rates awarded on a fixed-rate mortgage. That means that borrowers with adjustable-rate mortgages have lower monthly payments during their introductory term than borrowers with fixed-rate mortgages, possibly saving the borrower with the adjustable-rate mortgage thousands of dollars.
Disadvantage: Smaller Loan Amounts
Because the interest rates on adjustable-rate mortgages are lower, some borrowers are able to afford to purchase more expensive homes than they would be able to if they financed their home with a fixed-rate mortgage. For example, if a borrower who had been given a 6 percent interest rate on a fixed-rate mortgage could only afford a $600 monthly mortgage payment, the largest mortgage loan they could take out would be $100,000. However, if the same borrower had been given an introductory rate on an adjustable-rate mortgage of 5 percent, they would be able to borrow up to $112,000.
Disadvantage: Interest Rates Don't Fluctuate
For many, the fact that the interest rate doesn't change on a fixed-rate mortgage is an advantage--it ensures stable payments over the life of the loan. However, while fixed interest rates don't rise with the prime rate, they also don't fall with it. If interest rates were to significantly lower during your mortgage term, you would have to refinance your home in order to take advantage of those lower rates.
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