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Fixed Rate Mortage - Why You Should Get a Fixed Rate Mortgage

rates arm introductory rise

You see a lot of ads for adjustable rate mortgages these days, but that doesn’t necessarily mean they are a good deal. In fact, the main reason you see so many of these ads is because they are not a good deal for the consumer. In the current economy, the bank stands to make a lot more profit on an ARM in the long run than you will save during the introductory period when the interest rate is the lowest. That is why they are so heavily advertised. If you really want the best deal on a mortgage, a fixed rate mortgage is the way to go.

Why is a fixed rate mortgage better? The answer to this question is easy to see when you look back through past mortgage rates. Although the 1% savings on an ARM looks pretty good compared to the fixed rate now, it is unlikely that the historically low mortgage rates of recent years will last. Looking through historical rate charts, you can see that interest rates for 30-year fixed mortgages mostly hovered between 9% and 10% during the first half of the 1990s. Going back even further, you’ll find rates ranging from 10% to 15% in the 1980s.

If you get an adjustable rate mortgage, your interest rate and payment can rise significantly if the prime rate rises. In addition, most ARMs have an introductory rate that is much lower than the fully indexed rate. If you get an ARM with an introductory rate of 3.5%, it could easily rise by 2-3% or more when the introductory rate is over, depending on the terms of your mortgage. By paying an average of additional 1% in additional interest at first on a fixed rate mortgage, you will likely save a significant amount over the term of the loan even if rates remain low.

However, the chances of rates staying low are not good. As the economy recovers, the prime rate will likely rise and banks will charge higher rates for mortgages. An example might help you understand just how much you can save with a fixed rate mortgage. Let’s say you have a choice between a fixed mortgage rate of 5% or an introductory ARM of 4%. In this example, we’ll assume that the ARM adjusts to the prime rate plus 2% after a 1-year introductory period.

After one year, the interest rate on the fixed rate mortgage will still be 5%, whereas the rate on the ARM will rise to 6%, even if mortgage rates do not rise. Now let’s look at these loans a few years down the road. Obviously, no one can know for sure how much interest rates will rise, so these numbers are hypothetical. However, if the prime rate rises to 6%, the interest rate on your ARM will now be up to 8%. On the other hand, a fixed rate mortgage doesn’t change, so you would still be paying 5% if you had opted for the fixed rate mortgage.

The bottom line is that while interest rates are low, the only way they can change is to go up. It is extremely unlikely that your interest rate will drop even lower than the current rate, especially taking into account that the rate you start with is an introductory rate. Therefore, the only type of mortgage that really makes sense in the current economy is a fixed rate mortgage.

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