subject: Choosing Between Frm And Arm: A Tough Call [print this page] Choosing between a fixed rate mortgage (FRM) and an adjustable rate mortgage (ARM) is a tough call that the borrowers have to make. Both of these mortgages have some inherent advantages and disadvantages. Here we try to make a comparative analysis among these two broad types of mortgages.
Fixed rate mortgages
These are the most common type of mortgages. As the name suggests, the mortgage rates and the monthly payment amounts associated with fixed rate mortgages are fixed. Usually, these types of mortgages can be of 15-year and 30-year duration. These types of mortgage loans are very popular among the consumers because of the fact that they are not comfortable with their monthly payments rising or falling with fluctuations in the rate of interest. Moreover, when the mortgage rates are very low, FRMs are comparatively more affordable then the adjustable rate mortgages.
Again, while choosing a fixed rate mortgage, the problem boils down to the selection between a 15-year FRM and a 30-year FRM. Both, a 15-year loan and a 30-year loan have certain advantages and disadvantages. A 30-year fixed rate mortgage offers you the chance to borrow money on a long term basis without worrying about interest rates or monthly payment amounts changing.
Monthly payment amount on a 30-year mortgage loan is lower than the monthly payment amount on a 15-year mortgage loan, because in case of a 30-year mortgage loan, interest is amortized over a longer period of time. Lower monthly payment amount frees up some money for the borrowers which they can use for investment purposes which fetch more returns. But, in case of a 30-year fixed rate mortgage, borrowers can build up equity at a very slow pace. Moreover, the total interest payment over the life of the mortgage loan is much higher because of long amortization period.
In case of a 15-year mortgage loan, due to shorter amortization period, borrowers can build up equity in a relatively short period of time. The total interest payment that you make over the life term of the loan is comparatively less than the total interest payment that you make in case of a 30-year mortgage loan. The monthly payment amount is however higher than the monthly payment amount on a 30-year mortgage loan.
Adjustable rate mortgages
In case of adjustable rate mortgages, the rate of interest and the monthly payment amount vary as the prevailing market rate of interest rate fluctuates. For ARMs, interest rate does not change for the initial few years. But, for the major remaining part of the loan term, rate on an ARM changes with fluctuations in the market rate of interest. Rates on an ARM during the initial period are comparatively low then the rates on comparable fixed-rate mortgages.
After the initial fixed rate period, the rate on an ARM fluctuates with changes in the market rate of interest. With new market interest rate index, the new mortgage rate and the monthly payment amount is recalculated. The same process is repeated with every change in the interest rate index.
Now the choice to select a particular type of mortgage loan an ARM, a 15-year FRM or a 30-year FRM rests upon the borrower. The low initial cost associated with an ARM is indeed very enticing to the home buyers, but it carries more uncertainty with it. On the other hand, the mortgage rate and the monthly payment amount are fixed in case of a FRM but a fixed rate mortgage is more expensive than an adjustable rate mortgage.
