Interest Rates – Fixed or Adjustable?

What Is a Mortgage Interest Rate?

A mortgage interest rate a percentage of your total loan balance. That amount is added to your monthly payment and you will pay it along with your principal payment, and insurance until your loan is paid off. Lenders are businesses and businesses must generate revenue. Lenders charge interest rates, fixed or adjustable, to make money on the amount loaned to homebuyers.

As mentioned in the definition of mortgage, the borrower will pay the loan amount in full through installment payments with interest to the lender, but you get to decide on the best way for you to pay the interest.

The Two Types of Rates

The most common type is a fixed-rate mortgage, which locks in the interest rate when the loan is established and remains the same for the entire loan term. If you like having a set amount that you know won’t change later, this is a good option.

With an adjustable-rate mortgage (ARM), the interest is more complicated.  With this type of interest, the rate is fixed for a specific amount of time, and then it adjusts. Throughout the years of your mortgage (often every 3 to 5 years), an adjustable interest rate will be recalculated based on an index rate, and your interest rate could fluctuate. A strong economy may leave you at a lower rate and paying less interest, while a weak economy can leave you at a higher rate and paying more in interest. Adjustable-rate mortgages are recommended if you need a lower payment and plan to stay for a short time in your home. (Read more at Bankrate.com.)

Whichever option you choose, both mortgages offer the ability to refinance. If you have a fixed-rate mortgage and federal interest rates are lower than when closed, you can apply for a lower interest rate to reset the mortgage terms and take advantage of the lower rate. By definition, the adjustable-rate mortgage is already refinancing every few years, but at any point, you have convertibility and can decide to apply for a fixed-rate mortgage. Be aware that anytime a mortgage is refinanced, closing costs are charged, and these costs can add up. A small saving in interest payments might not financially justify the up-front costs to refinance.

Glossary of Common Mortgage Terms

Adjustable-Rate Mortgage (ARM) A loan that recalculates the interest rate. After the ARM fixed-rate period ends, the interest rate mortgage moves up and down based on the index it is tied to. The index is an interest rate set by market forces and published by a neutral party. There are many indexes, and the loan paperwork identifies which index a particular adjustable-rate mortgage follows.

Annual Percentage Rate (APR) The yearly cost of credit over the life of a loan. Typically includes interest, service charges, points, loan fees, mortgage insurance, and various other mortgage items.

Closing The process of transferring funds to pay for a property, paying fees and closing costs, and the signing of documents that transfer the deed for a property from a seller to a buyer.

Closing Costs Charges incurred and due for obtaining a mortgage loan and transferring real estate title.

Closing Date   The date set by all parties to finalize the transfer of property and to be referenced within the mortgage contract for legality.

Conventional Mortgage Type of loan that is not insured by a government agency (such as FHA or VA).

Convertibility The ability to change a loan from an adjustable-rate schedule to a fixed rate schedule.

Default A breach of a mortgage contract. Usually from not making mortgage payments for a certain period.

Escrow The handling of funds or documents by a third party on behalf of the buyer or seller.

Federal Housing Administration (FHA) A federal government agency that insures mortgages for financial backers.

Fixed-Rate Mortgage A mortgage with an interest rate that remains constant over the life of the loan.

Funding Fee A one-time fee applied to VA mortgages paid by qualified service members or surviving spouses.

Mortgage A loan with a contract for the buyer to agree to repay principal and interest to the financial institution funding the sale, with the property used as collateral while payments are repaid in installments over a specified period.

Principal The full amount borrowed in a loan that excludes interest and other charges.

Private Mortgage Insurance (PMI) A type of mortgage insurance for conventional loans usually required for loans with smaller down payments (less than 20%).

Refinance To finance (something) again, typically with a new loan at a lower rate of interest.

Settlement See closing.

Title A deed or certificate legally confirming the ownership of property. During a mortgage, the financial intuition that funded the purchase money will legally own the property and hold the title until the buyer has met all mortgage financial requirements.

Veterans Administration (VA) A federal government agency for active or honorably discharged veterans and surviving spouses that offers mortgages with reduced or waived down payments and/or mortgage insurance, but a funding fee may be applied.