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Why fixed-rate mortgages remain popular

The Mortgage Bankers Association also reported that 79 percent of all applications for the week ending July 7, 2010 were for refinancing mortgage loans. While the report does not reveal how many of those applicants were switching from an ARM to a fixed-rate mortgage, it is likely that at least some of the borrowers decided to refinance in order to make the move to a fixed-rate home loan.

Advantages of a fixed-rate mortgage

While ARMs are appreciated for their lower initial mortgage interest rate, many ARM borrowers have found themselves in trouble when their payments were adjusted to a higher rate. The main advantage of a fixed-rate mortgage loan is that the payment for monthly principal and interest will stay the same for the entire length of the loan until you pay the loan in full or refinance. Your housing payment could change due to shifts in your taxes or homeowners insurance, but those parts of your payment are typically much smaller than the principal and interest portion.

Refinancing a mortgage into a fixed-rate loan, particularly when mortgage rates are low, provides protection against interest rate adjustments. If interest rates increase, you will still be paying your loan at the original fixed rate. This means that fixed-rate mortgage loans are considerably less risky than other types of loans.

Disadvantages to a fixed-rate mortgage

As with any loan product, fixed-rate mortgages have some disadvantages too. First, since your mortgage rate won't go down even if interest rates drop, you won't be able to pay a lower interest rate unless you refinance your loan. Second, interest rates on a fixed-rate loan are typically slightly higher than the initial interest rate on an ARM, so you may not qualify for as large a mortgage loan as you would with an ARM.

Since the overwhelming majority (95 percent) of all mortgage applicants, whether they are refinancing or buying a home, opt for a fixed-rate loan, it is clear that the above disadvantages are not enough to tempt many borrowers into an ARM. An ARM can be a valuable loan product for borrowers who are certain they will sell their home before their interest rate adjusts, but clearly most consumers these days prefer the certainty of a fixed-rate loan.

Even within the world of fixed-rate mortgage loans, there are a few options for borrowers.

Options for a fixed-rate home loan

  • While most consumers are familiar with the 30-year fixed-rate home loan, these mortgage loans are also available with shorter payoff dates. The 15-year fixed-rate home loan is popular with borrowers who want to pay off their loan faster and build equity more quickly. Often, these loans carry a slightly lower interest rate than a 30-year loan, but the payments will be higher because of the shorter term. Homeowners who want to refinance and have already paid off 10 or 20 years of their existing home loan may way want to consider accelerating their payoff date with a loan term of 10, 15 or 20 years.
  • Interest-only fixed-rate mortgage loans are another option for borrowers who want to keep their initial mortgage payments as low as possible. These loans will have the same interest rate for the entire length of the loan. A typical interest-only fixed-rate mortgage will have a 10-year period of interest-only payments followed by a 20-year period in which they pay principal and interest. The lender should qualify borrowers for the full payment amount from the beginning to be sure they can afford the significantly larger payment. Borrowers with this type of loan should be careful to budget for the increase in their mortgage payments during the second period of the home loan.
  • Bi-weekly mortgages are set up so that the payments are made every two weeks, meaning that 26 payments will be made each year. A bi-weekly mortgage will result in one extra mortgage payment each year so that the borrower pays the loan faster and builds equity more quickly. Many borrowers opt to make additional mortgage payments on their own with a conventional home loan.

If you are considering applying for a mortgage, make sure you understand the pros and cons of each type of home loan before you choose the one that fits your financial circumstances.

 

 

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