Having your own home makes life a lot easier. But not many people can have so much of cash to pay for a house. So they may have to borrow money from banks or lenders. A large portion of the value of a house or property is financed by these lenders, which is called mortgage loan, the amount of which has to be repaid with interest over a predetermined period of time.
There are different types of mortgages, most common of which is the fixed rate mortgage, adjusted rate mortgage and the balloon mortgage. There are benefits and disadvantages in any type mortgage payments. The choice of making the right option mainly depends on the duration of your stay in the house bought, using the mortgage loan and the affordability of making a convenient periodical repayment.
In case of a fixed rate payment, the interest rate and so the monthly amount is fixed over the entire term of your loan. This will not change irrespective of the extreme fluctuation in the interest rates in the market. This enables the home owner to be sure of what would be the cash outflow with regard to the home loan. Those who are on a tight budget and with a fixed income can benefit from this.
In case of an Adjusted Rate Mortgage (ARM) payment, the interest rate changes with the rise and fall in the market rate, after the ARM period has expired. And hence, the monthly payment is also not fixed. ARMs are unique in that the interest rate on mortgage loan is adjusted with the market rate. When there is a rise in the market rate the monthly payment also increases. When there is a fall in the market rate the monthly payment also decreases, only after the ARM has re-set.
Fixed rates are usually at a higher rate than the ARM rate, but at the time when there is a fall in the market rate, the home owner can go in for a refi at a lower rate. In case of an ARM, there is the risk that the rate may increase drastically, making the payment, which was previously affordable, a burden which may result in default on the debt. Hence precautions are to be taken while taking ARM loans. There are caps on the interest rate or on monthly amount or a guaranteed number of years that must be passed before the interest rate can be adjusted. The caps on ARM are provided in order to protect the borrowers from drastic increase in monthly payments.
Initially, the ARM rate is offered lower, since the borrower is willing to take the risk of an increase in the interest rate. The fixed rate will be higher as the risk is with the lender, since at the time of increasing interest rate the lender will be lending at a lower rate. People with tight budget or a fixed income can go in for fixed rate so that they are sure of what their payment will be. At times of falling interest rates, ARMs can be beneficial.