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Fixed Mortgage Versus Variable Mortgage

What is a Fixed Rate Mortgage? This is the most common mortgage loan arrangement in the U.S. With a fixed-rate mortgage the loan's principal and interest are amortized, or spread out evenly, over the life of the mortgage loan, giving you a predictable monthly mortgage payment.

The upside to a fixed rate mortgage is, if mortgage rates are low, you can lock in for as long as 30 years and protect yourself against rising mortgage interest rates. However, if mortgage interest rates fall you can't change your mortgage interest rate without refinancing the mortgage loan, and that could cost money.

The 30-year Fixed-Rate Mortgage, the most popular and easiest mortgage to qualify for, will give you the lowest payment. But you can also get a 20-, 15- and even a 10-year fixed-rate mortgage if you wish to save mortgage interest and pay your home mortgage off sooner.

How Can I save on a Fixed Rate Mortgage?

Short Term Mortgages
You don't have to finance your home on a 30 year mortgage. Granted, the mortgage payments will be lower, but you'll be paying them longer. You could, instead, option for a mortgage period of 20, 15 or even 10 years, pay your home mortgage off sooner and save in mortgage interest.

Furthermore, mortgage lenders offer much more attractive mortgage interest rates with short-term mortgage loans, so your mortgage payments may not be as much as you'd think.

The table below shows you the mortgage interest savings on a $100,000 loan at 8.5% interest:

By paying $215.83 more a month on a 15-year mortgage, you'd save $99,555.83 in mortgage interest over a 30-year mortgage loan - and own the house in half the time.

Bi-Weekly Mortgage Payments
Instead of paying 12 monthly mortgage payments you can choose to make 26 bi-weekly mortgage payments. Here's how it works.

Each bi-weekly mortgage payment is the equivalent of half a monthly mortgage payment, but at the end of the year, it totals 13 months instead of 12. A 30-year mortgage could be paid off in 22 years. If you only qualify for a 30-year loan, this is a fabulous way to increase your mortgage equity sooner and save on mortgage interest.

What is an Adjustable Rate Mortgage?

With Adjustable-Rate Mortgages (ARMs) interest rates are tied directly to the economy so your monthly mortgage payment could rise or fall. Because you're essentially sharing the market risks with the mortgage lender, you are compensated with an introductory mortgage rate that is lower than the going fixed rate mortgage.

How often does the mortgage interest rate change?
That depends on the mortgage loan. Changes can occur every six months, annually, once every three years or whenever the mortgage dictates.

How much can my mortgage rate change?
Your ARM mortgage will stipulate a percentage cap for each mortgage adjustment period, which means your mortgage interest may not increase beyond that percentage point. If the market holds steady, there may be no increase in your mortgage at all. You may even see your mortgage payment decrease if mortgage interest rates fall.

How are the changes determined?
Every ARM mortgage loan is tied to a financial mortgage market index, such as CDs, T-Bills or LIBOR rates. Your mortgage rate is determined by adding an additional percentage (known as a margin) to that index's mortgage rate. When the index rises or falls, your mortgage rate rises or falls with it.

Is there a limit to how much mortgage interest I'll be charged?
Yes. It's called a ceiling, or lifetime mortgage cap. This is a guarantee that your mortgage interest rate will never exceed a designated percentage. For instance, if your introductory mortgage rate was 5% and you have a lifetime mortgage rate cap of 6% (meaning that your mortgage interest rate can never increase more than 6% during the life of the mortgage loan) then your mortgage ceiling would be 11%.

What are the benefits of an ARM?

• With a lower initial mortgage interest rate (usually 2% to 3% lower than fixed-rate mortgages), qualifying is easier and the mortgage payments are more manageable at first.
• You may qualify for a larger mortgage loan than you would with a fixed-rate mortgage.
• If you're only planning to stay a short time the mortgage interest rate is likely to stay lower than that of a fixed-rate mortgage.
• If you expect regular pay increases that would cover the increase in your mortgage interest, or if you believe mortgage interest rates will fall, an ARM mortgage might be the wiser choice.

A few words of caution:

Negative Mortgage Amortization -This happens when a mortgage lender allows you to make a mortgage payment that doesn't cover the cost of the mortgage principal and mortgage interest. Watch for this. It may be used as a lure to get you into a home with the promise of low initial mortgage payments. Or, a mortgage lender may give you a mortgage payment cap instead of a mortgage rate cap. In this mortgage arrangement, if mortgage interest rates increase, your monthly mortgage payments could stay the same - but the higher mortgage interest will still be charged to your mortgage loan, adding to it instead of reducing it. Either way, if you find yourself with a negative amortization ARM mortgage , you'll be adding to your mortgage debt.

Discounted mortgage interest rates - Sometimes a mortgage lender will advertise an unusually low initial mortgage rate. This is a discounted mortgage rate, and it's essentially a marketing tool. If your ARM mortgage offers a discounted mortgage interest rate you are certain to see an increase at your next mortgage adjustment period, even if mortgage interest rates don't change.