When it comes to structuring home loan rates, there are several ways to do so, but we will choose to focus on the two most common ones – Fixed Rate Mortgage (FRM) and the Adjustable Rate Mortgage (ARM) Their main difference, as is evident from the terms, is the interest rate based on the loan amount over time, which can vary depending upon the pre-decided rate or as per the changes in the index rate applied to your loan.
Definition of FRM and ARM
The FRM is self explanatory – the loan rate is set at the beginning of the loan and doesn’t alter for the entire duration, which is why it is known as a fixed rate loan. The rate is dependent upon the state of economy during that time, since lenders would definitely wan to protect themselves from fluctuations in the market. The ARM can also somewhat shield the lender if the interest rates happen to increase over a certain period of time. The rate is flexible, which is why when the increase in the rate goes up to a particular level, the lender can adjust the interest rate accordingly and increase the payment amount for the remaining loan term.
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ARM Pros & Cons
This is a comparatively new kind of mortgage – it was created when the fixed mortgage rates shot up, and ARM gave them a loophole for initial rates to be set much lower than current fixed rates and modified as per a predetermined formula in the future. ARM is much more affordable to borrowers initially, and lenders can play safe without risking anything as long as interest rates go up. But that very feature can become a nightmare for borrowers, if they are forced to pay a higher interest rate all of a sudden. If you go for ARM, ensure you have sufficient funds to cover the principal along with the interest should it increase.
Fixed Pros & Cons
It is a win-win for the lender at a time when rates are on a rise since fixed rate mortgages can be set at a higher margin. This allows the lender to set a relatively higher loan rate without the possibility of losing his capital. The rate remains same, which works for the lender even if the interest rates suddenly fall. It is beneficial for the borrower because the monthly payment plan remains same and when you know the exact interest rate, you can distribute your income in a more organized way. It is easier to chalk out a budget and plan expenses for some time ahead.
Appraise your financial situation and then choose – use the figures from the calculator to make an informed decision.