What is the Difference Between a Fixed-Rate and Adjustable-Rate Mortgage?
There are two kinds of conventional loans: a fixed-rate mortgage and an adjustable-rate mortgage. Both mortgages have benefits for you.
The fixed-rate option is best if you are planning to own your home for at least seven years. The interest rate for this loan will not change over the term of the loan, no matter what happens in the market. That means that the total amount of your principal plus interest will not increase over the lifespan of your loan.
- Rate protection - your rate stays the same even if mortgage rates go up
- Payment stability - you will always know what your monthly payment will be
- Budgeting ease - budgeting your mortgage expense is easier because your payment does not fluctuate
- Earlier pay-off - even with a fixed rate, you can make extra payments to pay off your loan sooner
An adjustable-rate mortgage, or ARM, is a loan with an interest rate that may fluctuate over time but only after an initial "fixed" period (typically 5 or 7 years). An ARM will offer a lower introductory interest rates and then adjust after the initial term. Common types of ARM loans are 5/1 or 7/1 loans. The first number tells you how long the introductory fixed-rate period will be (five or seven years), and the second number tells you how often the interest rate will adjust after (every year).
- Lower rates - during the fixed period, the interest rate is often lower than for other loans
- Lower payments - when your interest rate is low, your payments will be lower, too
- Lower cost - if you are planning to own your home for only five to seven years, this option keeps your payment lower for the initial term of the loan
- Rate caps - control how much your rate can increase