Fixed-Rate Mortgages
In a nutshell, a fixed-rate mortgage charges a set rate of interest that doesn’t change throughout the life of the loan. At the beginning of a fixed-rate mortgage, the payment will consist of mostly interest with a smaller amount of principal. However, as time goes on, this proportion will reverse so that you're paying more and more towards principal and less and less to interest.
The primary advantage of a fixed-rate mortgage loan is that the borrower is protected from sudden and potentially significant increases in monthly mortgage payments if interest rates rise. Fixed-rate mortgages typically vary little from lender to lender. Although the rate of interest is fixed, the total amount of interest paid depends on the mortgage term. The most common fixed-rate mortgages are 30, 20 and 15 years.
The 30-year fixed-rate mortgage is the most popular choice because it offers the lowest monthly payment; however, the trade-off for that low payment is a significantly higher overall cost because the extra decade, or more, in the term is devoted primarily to paying interest. The monthly payments for shorter-term mortgages are higher so that the principal is repaid in a shorter time frame. Also, shorter-term mortgages offer a lower interest rate, which allows for a larger amount of principal repaid with each mortgage payment, so shorter-term mortgages cost significantly less overall.
Adjustable-Rate Mortgages
In a nutshell, the interest rate on an adjustable-rate mortgage (ARM) varies over time. The initial interest rate on an ARM is set below the market rate on a comparable fixed-rate loan and will stay at that level during it's fixed period, which can last anywhere from one year to 10 years. As a rule of thumb, the shorter the initial fixed period, the lower the initial rate. After that fixed period, however, the rate can move higher (or lower) depending on a number of factors.
