What kind of interest rate is best?
There are two types of interest rates: fixed rate and variable (or adjustable) rate.
FIXED RATE The interest rate and monthly payment (not including taxes and insurance) does not change over the life of the loan. This is the most common type of long term (15-30 years) loan.
ADJUSTABLE RATE (ARM) The interest rate and monthly payment (not including taxes and insurance) are subject to change many times (usually each year) over the life of the loan. The advantage is that the starting interest rate is lower, typically 1-2% lower, than a fixed rate loan, and hence the monthly payment is lower. The disadvantage is that the rate can surpass a fixed rate loan in just a couple of years, and this means an increase in the monthly payment accordingly. There is usually an annual "cap" or ceiling of 2% based on the prior year's rate, with a maximum rate that can be charged, normally 5% over the initial interest rate. So if an adjustable rate loan starts at an attractive 3.00%, it can quickly go to 8.00% in just a few years, several points higher than an 4% fixed rate loan. Many ARM loans provide for a conversion to a fixed-rate loan at some time in the future, based on a formula. However, you will not know what that formula will yield as a fixed rate at the time of the conversion. You can only hope that the rate will be reasonable at that time.