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What are the advantages of fixed-rate versus adjustable-rate loans?

Fixed-rate loans are, simply put, loans that have a guaranteed fixed interest rate for the entire term of the loan.  Generally, these loans are fully amortized (meaning the payment retires the entire debt over the term of the loan) so that your monthly payment (exclusive of taxes and insurance) remains constant for the entire term. There are also fixed-rate loans which have an introductory period during which the payments are based on interest only.  Usually 10 or 15 years into a 30 year interest only fixed-rate loan, the lender requires that amortizing payments be made.  So, in this type of loan, your interest rate remains constant, but your payments do change.

Fixed-rate loans are available in all sorts of shapes and sizes: 30-year, 20-year, 15-year, even 10-year. In most cases, these loans are fully amortized (the payment results in a zero balance at the end of the term) although as mentioned, some are interest only, or may have a balloon payment some stated number of years into the loan.
You might choose a fixed-rate loan if you plan to keep your property long term, you are relatively certain you will not be refinancing, or the risks of an adjustable rate loan outweigh the potential rewards.

Adjustable-Rate Mortgages, known as "ARMs", come in even more varieties. Generally, ARMs determine what you must pay based on an outside index, perhaps the 6-month Certificate of Deposit (CD) rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others. Most commonly, they may adjust every month, every six months, or once a year. 

Most programs have a "cap" that establishes a maximum your monthly payment can go up at once. There may be a cap on how much your interest rate can go up in one period -- say, no more than two percent per year, even if the underlying index goes up by more than two percent. You may have a "payment cap," that instead of capping the interest rate directly caps the amount your monthly payment can go up in one period. In addition, almost all ARM programs have a "lifetime cap" -- your interest rate can never exceed that cap amount, no matter what.

ARMs often have their lowest, most attractive rates at the beginning of the loan, and can guarantee that rate for anywhere from one month to ten years. You may hear about loans that are called "3/1 ARMs" or "5/1 ARMs" or the like. That means that the introductory rate is set for three or five years, and then adjusts according to an index every year thereafter for the life of the loan. Loans like this are often best for people who anticipate moving -- and therefore selling the house to be mortgaged -- within three or five years, depending on how long the lower rate will be in effect.

You might choose an ARM to take advantage of a lower introductory rate and count on either moving or simply absorbing the higher rate after the introductory rate goes up. With ARMs, you do risk your rate going up, but you also take advantage of lower adjustable rates by pocketing more money each month that would otherwise have gone toward your mortgage payment.
Deciding which type of loan is best for you involves a number of factors. As with any investment you might make there are risks and rewards to be considered when structuring your debt. Fixed-rate loans offer the lowest degree of risk, with the highest degree of predictability. However, they generally cost more than adjustable-rate financing and in a declining interest rate market they do not adjust to changing market rates. ARMs offer the immediate reward of a lower rate plus they may offer the potential for lower rates should market rates drop. The risk, of course, is that the adjusted rate over the life of the loan could be higher than what a fixed-rate would have been.  In extreme cases the adjusted rate could result in a payment that is above what a borrower can afford.   
Our Loan Specialists are experts at analyzing your situation and helping you to find a solution that meets your financial needs and matches your risk tolerance.  Please do not hesitate to call on us for assistance.