Features & Benefits of Fixed and Adjustable Rate Home Loans

The main feature of fixed rate home loans is that the interest rate will not change.  These mortgages provide security to the borrower as they will not have to worry about mortgage rates changing.

This means your mortgage or  home loan payment (principal and interest) will not change.   However, if you are escrowing or impounding (including) your real estate taxes and homeowner's insurance in your mortgage payment, your total mortgage payment may change as taxes and insurance change.

The Tradeoff:  For the security of knowing your monthly mortgage or home loan payment will never increase, the interest rate will likely be higher than the rate on an adjustable rate mortgage, especially in the early years of the mortgage term.

Features of an ARM include:

• Starts with a lower initial interest rate, typically it is lower than a fixed-rate loan to start.
• The interest rate adjusts periodically after the initial term expires (anywhere from 1 to 10 years), depending on movements in market interest rates.
• Your monthly mortgage payment could increase or decrease in the future, based on the annual adjustments to the interest rate on the loan.

An adjustable rate mortgage can be good for those that know they will be in the home for a short period of time, typically less than five years.

Determining the interest rate on an ARM loan

The interest rate on an adjustable rate mortgage is determined by adding a margin to an index.  

Example of an index include the Prime Rate, Treasury Bills, LIBOR (London interbank offer rate) and COFI (cost of funds index). 

A margin, such at 2% is added to the index to determine the rate.  While the margin does not change, your interest rate changes as the index changes.   

Interest only home loans or mortgages allow the homeowner to pay only the interest portion of the mortgage for a specified period of time, usually ten years.  

These were used in the past by savvy investors to help increase cashflow on rental or investment properties.  However due to abuses during the mortgage meltdown these typically allowed owner occupied properties and have much tougher qualifications.