Fixed or Adjustable: Which is Best?

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

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