When you purchase a home for the first time, one of the most important things you will have to figure out is whether a fixed rate or adjustable rate mortgage (ARM) is best for you. First, of course, you need a clear idea of what they are.



Fixed Rate Home Mortgage

To put it simply, the interest rate of a fixed rate home mortgage is unchanging. This rate is frozen for the term of the loan, meaning that your rate will stay the same no matter what happens to interest rates over the term of the loan. Many new buyers decide to go with a fixed rate home mortgage, since these mortgages make it easier to plan for the future. As the interest rates you are paying on your home mortgage are always the same, so are your mortgage payments. This means that if you purchase a home for $175,000 at rate of 6.5% for 30 years, your monthly home mortgage payments will stay at $1106 (excluding any escrow costs), and never deviate during the course of the term.

There are upsides and downsides to going with a fixed rated home mortgage. While you will always be able to depend on a fixed mortgage payment (excluding property tax and insurance), you will typically have a higher interest rate than if you used an ARM. This is because banks are generally taking on more risk with fixed rate loans, and so charge you more for keeping a frozen rate for the duration of your home mortgage.

A Home Mortgage with Adjustable Rate Interest

An adjustable rate home mortgage is often called a floating rate, as your rate changes along with interest rate indexes. Typically, adjustable rate mortgages begin with a short period in which the rate is fixed (usually 3 to 10 years). After that time, the rate will adjust at predetermined intervals. At these adjustment periods the rate you pay will rise and fall along with whatever index your rate is tied to. Simply put, if rates go up, your home mortgage payments will go up as well.

In general, a variable rate home mortgage starts with a lower interest rate than a typical 30 year fixed rate mortgage. But if interest rates go up, your payments will go up. To reduce some of that risk, many ARMs come with a rate cap, allowing your rates rise only a specified number of percentage points.

The key to choosing the right loan for you is knowing how long you will be in your home and understanding your tolerance for risk. If you plan to stay in your home only a few years, its possible for you to save money by choosing an adjustable rate home mortgage with a lower fixed rate for the first few years of the loan. Chances are, you will have left the house before your rates ever change. If you plan to stay in your home a long time and do not want to deal with changing interest rates, a fixed rate option might be best for you.