What is the difference between Fixed and Adjustable Rate Mortgage?
A fixed rate mortgage is just that – fixed, not changing. Fixed rate mortgages have an interest rate that remains the same for the term of the loan. With a fixed rate mortgage, you know exactly what you are going to pay each month for the life of the loan. If interest rates drop dramatically, you can always refinance to get a better rate; if interest rates go up, you’ll be smart for having locked in a lower rate. Fixed rate mortgages are one of the easiest mortgages to understand and budget for. The most popular terms for a fixed rate mortgage are 15 or 30 years.
One advantage to an adjustable rate mortgage (ARM) is typically they offer a lower initial payment, however, with an adjustable rate mortgage (ARM), your monthly payments can change over time. Often times ARMs have a fixed initial rate for months or years. After that, the interest rate will be adjusted each year. The adjustment will be based on an index specified in the mortgage agreement. If rates stay low with to very minimal changes another advantage to an ARM is you could find yourself saving significant money in interest charges.
When you’re shopping for mortgages, you’ll see ARMs listed as 1/1, 3/1, 5/1 and so on. The first number indicates how many years the initial fixed rate will last. The second number tells you how often the interest rate will be adjusted thereafter. This number is almost always a 1 to indicate an annual adjustment.
Before taking out an adjustable rate mortgage, find out:
- How high your interest rate and monthly payments can go with each adjustment
- How frequently your interest rate will adjust
- How soon your payment could go up
- Is a cap on how high your interest rate could go
- Is there a limit on how low your interest rate could go
- Will you be able to afford the loan if the rate and payment go up to the maximums allowed
More Common Mortgage FAQs
- Can I qualify for a mortgage with my credit score?
- How do I figure out how much I can afford?
- What is an FHA loan and how do I qualify?
- How much do I need for a down payment?
- What is PMI and can it be avoided?