Why are fixed mortgage rates and adjustable rates different?

Question

I just saw that a 30 year fixed mortgage is 6.07% and a 5/1 ARM is 5.91%. What are the reasons why these rates differ by nearly .2%?

Answer 1

The 30 year fixed will have the same interest rate (6.07%) for all thirty years of the mortgage. The 5/1 ARM will only have a fixed rate 5 years, and then will change (can go up) in the sixth year and every year after until thirty years. The first mortgage is riskier for the bank because they are guaranteeing the rate for all thirty years, so they charge you a higher rate of interest.

Answer 2

With a 30 year mortgage a bank has to guess what rates are going to be for the entire term and what yield they're losing on lending that amount of money to you for a longer period of time.
With a 5 year ARM they only have to commit for 5 years and then reset the rate to whatever the current market is. Obviously this is easier to do for shorter periods and much more accurate. The rates start a bit lower since they'll be corrected in 5 years when market conditions vary.
Like the above people have all stated the ARMs that are out there now are adjusting up by quite a bit. If you are considering that type of loan make sure you can afford the payment at the maximum rate the mortgage allows for in the time you'll be in the house. If not, then it's a very risky loan to sign up for.

Answer 3

A fixed mortgage is a mortgage at a set rate for a set period of time. An ARM can offer a lower beginning rate because it is adjustable over the life of the loan - meaning the loan company will take 5.91 now and in 5 years the rate can and will increase to 7+... The financier of the ARM will make their money back on the back end of the loan. These loans are how so many people got into trouble lately - they were able to qualify for a larger total mortgage because the payment on the ARM was do-able, but once the ARM expires and the rate adjusts so does the payment... I don't recommend an ARM with the market being so unpredictable - many people got one assuming that they could refinance at a do-able rate before the ARM expired, but because interest rates shot up they got screwed. Practice responsible lending - banks want to make the deal - you need to make sure you can make the payment...

Answer 4

A fixed interest rate remains the same through the entire loan, and an adjustable rate has a "float" where your interest rate can change dramatically, unless you are careful. If you take an ARM, make sure you get a cap and a ceiling, so you can still make your payments. A cap says they can't increase your interest by more than a certain percentage during any time period (ours was 2% every two years) up to a maximum ceiling that they can't charge above period(ours was 5% over the initial interest rate). The loan agent will have the same protections the other way, they will never charge less than the original interest rate. As you can see an ARM is a little riskier for the buyer, so they give you a lower beginning interest rate.

Answer 5

I'm not sure why people associate ARM's with bad credit. Any lender that offers a 5/1 ARM is a CONFORMING lender. That means you have to have GOOD credit to qualify.

Until yesterday, ARM rates were actually higher than fixed rates. The reason they are different is because different parts of the market control the different rates. The 30 year is controlled by what the 10 year bond does, and the 5/1 ARM is controlled by several markets, such as LIBOR. Prime rate is it's own market, which is controlled by the Fed (that's the rate they just dropped .50%). Prime rate has to do with variable rate loans, like a HELOC (home equity line of credit).

For more information, e-mail me. I'll be glad to answer any more questions you might have, as well as send you information about the different markets.

Answer 6

Because after the fixed period of the ARM is over, they can adjust your rates up based on some predetermined formula.

That's what is catching a lot of people now. A lot of people bought in thinking they could afford higher payments in the future by some miracle, or sell because their home would be worth more. They are now caught with higher payments and inability to sell for enough to break even after expenses.

I bought my place in April 2004, and when shopping for a mortgage, I was getting offered a lot of ARMS. If I would have taken one, I could have afforded a bigger place. However, at that time, interest rates were pretty much at historic lows, and I knew damn well that if I couldn't afford a fixed payment then, I wouldn't be able to afford the higher adjusting rate a few years down the road, so I went with smaller place that I could afford the payment on for a 30 year fixed mortgage.

Answer 7

The drawbacks are that they are only available for a limited time and, because they are set at a higher rate than the bank of England Base rate, there is always a risk that interest rates will go down and those on a fixed rate will lose out. This this happened a few years ago, but doesn't seem to be too much of a risk at the moment.

Answer 8

A fixed rate is for the life of the loan. When you see an ARM it is usually lower to sucker in the people who don't qualify for a fixed rate. As time goes on depending 0n the market for housing development the US government may decided to lower the rates or make them higher which in turn the mortgage companies, banks, credit unions and so on adjust it for themselves to make a profit. In other words the ARM wont stay that low for very long.

Answer 9

Because ARM's attract people with bad credit by confusing them with this seemingly lower rate. In 5 years, your payment can nearly double though - and rise every year after. Stick with the fixed rate, or lose your home in 5 years. It's happening all throughout the country right now...

Answer 10

ARM = adjustable rate mortgage
surely that's explanation enough