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Fixed Versus Adjustable Rates

There are good reasons to prefer a fixed-rate mortgage and good reasons to prefer an adjustable-rate mortgage. Learn all you need to know to choose the right type for you.

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Fixed-Rate Mortgages

When a mortgage has a fixed interest rate, it means the payment you have to make on your loan will be the same, every month, for the whole life of your loan.

The 30-year fixed-rate mortgage, the most conventional of all home loans, remains popular because many homebuyers like to know that what they have to pay next month will be about the same as what they have to pay thirty years from now. (We say “about the same” because even though your interest rate will stay the same, the amount you have to pay for taxes and insurance will change over time.) Another popular option is the 15-year fixed-rate mortgage.

Why Wouldn’t Everyone Get a Fixed-Rate Mortgage?This type of mortgage is nice and simple, and you don’t have to worry about your mortgage payments rising significantly in the future. But if you’re planning to sell your house and move away within a few years (like many Americans end up doing anyway), you may miss an opportunity to save money with an adjustable-rate mortgage, or ARM for short.

Adjustable-Rate Mortgages

Also known as variable-rate mortgages.

Lenders cannot just decide to adjust the rate on an ARM however they want from year to year.

An adjustable interest rate changes regularly, usually every year, to reflect what’s happening in the economy, and your monthly mortgage payment changes with it. Each adjustment may make your payments higher or lower, and though it is impossible to predict how the economy will be years from now, the terms of your mortgage will set the rules for how your interest rate is adjusted.

In the United States, lenders cannot just decide to adjust the rate on an ARM however they want from year to year — the rate has to be indexed to another commonly used interest rate in the financial industry. The ARM rate will rise if the index rises and fall if the index falls, within the limits of the ARM’s terms. With some ARMs, the adjustments are capped to keep the rate from changing too much or too fast. There are different types of adjustment caps:

  • A periodic cap limits how much the rate can change during a single adjustment.
  • A lifetime cap limits how much the rate can change over the whole life of the loan.

Most ARMs are actually hybrid mortgages. They have a fixed interest rate for a certain number of years, the introductory period, and then the rate begins to adjust regularly after that. The way an ARM is named tells you how long the introductory period is and how often the rate adjusts when it is over. Here are some examples:

The interest rate of the introductory period is often lower than any fixed-interest rate you could get.

  • A “5/1 ARM” is fixed for 5 years and then adjusts every 1 year.
  • A “10/1 ARM” is fixed for 10 years and then adjusts every 1 year.
  • A “5/5 ARM” is fixed for 5 years and then adjusts every 5 years.
  • A “15/15 ARM” adjusts once after 15 years.

The key to a hybrid mortgage is that the interest rate of the introductory period is often lower than any rate you could get with a fixed-interest mortgage. If you get a 5/1 ARM and then sell or refinance your home before the first 5 years are over, you get to take the savings and avoid the adjustments. For this reason, adjustable-rate mortgages are becoming much more popular options in the United States.

Think about how long you will likely stay in your home.

Pros and Cons

The type of mortgage you should choose depends on your outlook of the future.

Fixed-Rate Mortgages: Straightforward and Reliable

ProIf interest rates in the financial industry go up, you don’t have to worry about it. If interest rates go down, you can refinance to take advantage of it.

ConThe only risk of a fixed-interest mortgage lies in the money you could save during the introductory period of an ARM with a lower initial rate.

Adjustable-Rate Mortgages: For Homeowners on the Move

ProLike many Americans, you can save money with an ARM if you know you will be selling your home or refinancing before the introductory period is over.

ConIf you keep your ARM past the introductory period, however, it’s anyone’s guess whether your rate will adjust up or down from year to year.

View Sources
  1. Consumer Financial Protection Bureau. (n.d.). What Is the Difference Between a Fixed-Rate and Adjustable-Rate Mortgage (ARM) Loan? Retrieved from http://www.consumerfinance.gov/askcfpb/100/what-is-the-difference-between-a-fixed-rate-and-adjustable-rate-mortgage-arm-loan.html
  2. Investopedia.com. (n.d.). Adjustable-Rate Mortgage - ARM. Retrieved from http://www.investopedia.com/terms/a/arm.asp
  3. U.S. Department of Housing and Urban Development. (n.d.). Adjustable Rate Mortgages (ARM). Retrieved from https://portal.hud.gov/hudportal/HUD?src=/program_offices/housing/sfh/ins/203armt
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