Difference between a Fixed-Rate and Adjustable-Rate Mortgage (ARM)

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If you’re planning to buy your dream home, it pays off to spend time researching your mortgage options. Often in the excitement of buying a new home, people neglect to research different loan options. However, finding the best loan option is as important as choosing the right home. For a first time homebuyer, it’s obvious to get confused between conventional and government-insured loan programs, as well as for deciding on the right loan term and type of interest rate.

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Before you get a mortgage, it’s important to consider all the loan features and terms. Of all the key decisions, one of the most crucial is deciding whether to go with a fixed- or adjustable-rate mortgage. To choose the right type of mortgage, you need to understand the basics of both these loans and the pros and cons of each. Choosing between ARM and fixed-rate mortgage depends on your budget, housing needs and appetite for risk will be key factors in your decision. So, let’s find out the difference between these two loans types to help you pick the right one for your current needs and future goals.

Fixed-Rate Mortgages

When it comes to taking a mortgage, many home buyers gravitate toward the traditional fixed-rate mortgage. This type of loan is popular among homebuyers who prefer predictable budgeting. This loan offers stability because it locks the borrower in a fixed interest rate and monthly payments for the entire life of the loan. It means that the interest that does not change throughout the life of the loan which makes budgeting easy for homeowners. It also comes with flexible terms and you may opt for a 30-year mortgage or shorter terms, such as 15 or 20 years. A Fixed-Rate Mortgage is right for you if you want protection from sudden and potentially significant increases in monthly mortgage payments if interest rates rise. Also, understanding this type of mortgage is easier. However, qualifying for a fixed-rate mortgage can be tricky if interest rates are high.

Adjustable-Rate Mortgage

Adjustable-rate mortgage (ARM) is usually more appealing to first-time homebuyers because of their lower rates. Adjustable rates start low than fixed-rate mortgages but may change over time. This means that the monthly payments can go up or down depending on the market condition. Although the introductory interest rates are lower, the rate moves based on the index it’s tied to. Whether you’re a first-time homebuyer or at the staring of your career, an ARM may boost your buying power because of a lower introductory rate and flexibility. However, when this introductory period is over, your interest rate will change and your payment may go up. The most popular adjustable-rate mortgage is the 5/1 ARM where a lower introductory rate lasts for five years and then it may change once a year. There are also 3/1 ARMs, 7/1 ARMs, and 10/1 ARMs.

The lower rate feature allows people to buy more expensive homes than they otherwise could buy. Another advantage of an ARM is that if the interest rate falls in the future, borrowers get the benefit of falling rates without refinancing. However, if rates increase, your payments can rise significantly over the life of the loan. It is also difficult to understand complex ARM terminology.