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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
Home Buying For Dummies, by Eric Tyson, Ray
Brown. © 1997 by Eric Tyson, Ray Brown, used by permission of IDG
Books.
ISBN#: 1568843852
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