Adjustable Rate Mortgages Vs Fixed Rate Mortgages

Adjustable rate mortgage (ARM) or variable rate mortgage is the type of mortgage where the interest rate changes periodically, in concurrence to an economic index. This causes the monthly amount payable by the borrower to fluctuate over time.

ARM is different from the graduated payment mortgage where the payment amounts vary but the interest rate remains the same. In ARM, depending upon the index, the mortgage rate may fall, and the monthly payment amount also drops. On the other hand, when the rate rises, the repayment amount goes up as well, exposing the borrower to the hazards of financial burdens.

In fixed rate mortgages, the rate of interest remains stable. The monthly amount to be paid thus remains unchanged. This makes budget planning easier. However, the initial rate of interest in case of ARM is often 1% to 2% lower than the fixed rate mortgages. So at the beginning, smaller amounts are to be paid. Also, if the index to which the interest rate of ARM is connected goes down, a borrower following the fixed rate plan ends up paying much more than another who has taken a loan for an equal amount and an equal time period on the ARM system.

Adjustable rate mortgages offer the option to repay the principal amount borrowed before the loan tenure is over. No penalty charges need to be paid. Paying back at least a part of the capital diminishes the amount on which the interest is to be paid. This cuts down the total cost of the loan. The total time period required to pay back the borrowed amount is also reduced. This also provides the opportunity of refinancing, or repaying the entire loan amount when interest rates fall considerably.

Thus it can be said that an ARM is best suited for those who can afford to meet a sudden rise in the monthly repayment amount in case the interest rate rises. Those who feel that any radical change in their repayment scheme will jeopardize their financial plan would do better to settle for other mortgage types.

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