The Difference Between Fixed-Rate and Adjustable-Rate Mortgages

As a borrower, you’ll have the option of choosing either a fixed-rate mortgage (FRM) or an adjustable-rate mortgage (ARM). They both have their pros and cons. The primary difference is how the interest rate behaves over the life of the loan. Here’s what you need to know about the differences between fixed and adjustable loans.

Fixed-Rate Mortgage (FRM): This is the most popular type of loan among home buyers. As you might have guessed, it carries the same interest rate from start to finish. The rate never changes. This is true even if the length or “term” of the loan is 30 years. And since the rate stays the same, your monthly payments will stay the same as well. This is also the most popular option with homeowners who are refinancing their homes.

Adjustable-Rate Mortgage (ARM): This type of loan has an interest rate that changes or adjusts at predetermined intervals, over the life of the loan. They are also referred to as variable-rate loans, though the “adjustable” terminology is more prominent these days. Most ARM loans available today are actually “hybrid” products that start off with a fixed rate for a certain period of time, after which it will adjust every year (more to follow on this).

This is one of the first choices you’ll have to make when choosing a home loan. Do you want one with a fixed or adjustable interest rate? In order to make this decision, you need to understand the pros and cons of these two different types of mortgage products. So let’s talk about that next.

The Pros and Cons of Fixed-Rate Loans

The biggest benefit to using a fixed-rate home loan is the long-term stability it provides. For instance, if you secure a 30-year fixed-rate mortgage with an interest rate of 4.5%, it will remain at 4.5% for the entire time you keep the loan. This means your monthly payments will stay the same too. There is no fluctuation or uncertainty.

Those are the pros, but what about the cons? The downside to using this type of mortgage (over an adjustable-rate loan) is that you’ll pay a premium for that long-term predictability. The average rate for an FRM is generally higher than the average for an ARM loan. Refer to Freddie Mac’s weekly mortgage survey, and you’ll notice the fixed-rate products are priced higher than the adjustable ones.

The Pros and Cons of Using an ARM Loan

The primary benefit of using an ARM loan is the counterpoint of what we just discussed. On average, adjustable mortgage products have lower interest rates than fixed. This is the main reason why some borrowers choose the ARM over the FRM in the first place. You can typically secure a lower interest rate with an adjustable product, thereby reducing the size of your monthly payments.

The downside is that the rate will start to adjust at some point, and this could result in a monthly payment that actually rises over time. So while you might start off with a lower rate than a fixed mortgage, you’ll also face the uncertainty of future rate increases.

Which One Is Right for You?

So how do you decide between the ARM and the FRM? For starters, you need to think about how long you will be in the house, and/or how long you plan to keep the loan. This will help you choose the best type of loan for your situation.

If you plan to stay in the home many years, it might make more sense to use a fixed-rate mortgage loan. That way, you’ll avoid the uncertainty of rate hikes down the road.

If you think you’ll only keep the house for a few years, before selling and moving, you might consider the ARM loan. You could potentially save money on interest costs, while selling the home before the uncertainty of rate adjustments sets in.

If you are still not sure which loan is best for you, we often recommend Doug Walker @ Prime Lending . Doug knows the lending business and has a basket of Mortgage products you can select from.             

Plus no one explains the difference between fixed rate & adjustable rate mortgages as well as Doug does. Give him a call @ 801-244-7620.