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Port Townsend, WA

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Types of Home Loans

There are many different types of home loans, but to an extent they can all be classified as either fixed-rate or adjustable-rate. The important thing is to be sure you understand the definitions, as well as the pros and cons, of fixed-rate and adjustable-rate home loans. If you start with a good grasp of this concept, things will be much simpler as you continue learning about the types of home loans.

With a fixed-rate mortgage loan, your interest rate will never change, regardless of what the economy does. On the contrary, adjustable-rate mortgages (ARMs) have interest rates that adjust periodically during the life of the loan. (Terminology note: Adjustable-rate mortgage are also referred to as having a "variable rate.")

Fixed-Rate Mortgage Loan: Pros and Cons
As the name suggests, a fixed-rate mortgage is a mortgage where the interest rate stays the same over the life of the loan. As a result, your monthly mortgage payment does not change. Certainty is the primary benefit of a fixed-rate mortgage loan. You always know what your interest rate will be, regardless of what the economy does. The downside is that you'll pay a premium for this predictability, in the form of a higher interest rate.

When a mortgage lender grants a fixed-rate loan for a long period of time (like 30 or 40 years), they take on a certain amount of risk. If the prime interest rate goes up during the life of your loan, you will not have to pay the difference - the lender will. This is why they charge a higher interest rate than with an adjustable-rate mortgage.

Adjustable-Rate Mortgage (ARM) Loan: Pros and Cons
These days, most adjustable-rate mortgages start off with a fixed rate for an initial period of time, usually 3, 5 or 7 years. During this introductory period, the interest rate is fixed and will not change. After the introduction period, however, the loan converts to an adjustable-rate.

Overall, the interest rate on this type of home loan is lower than a traditional fixed-rate mortgage.

The downside is that you can never predict the interest rate it will adjust to after the introductory period. So in this regard, you can think of the initial period as a reward for the uncertainty of the adjustable period. You will start off with a lower interest rate than a regular fixed-rate loan, but you have the uncertainty of the adjustment phase.

During the adjustable phase of the mortgage, your monthly payments will rise and fall with average interest rates. It would be great if they fell, but bad if they rose. The important thing to remember is that you'll have no way to predict the average interest rates in advance, so the adjustable nature of the loan is something of a gamble.

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