What is the difference between a fixed-rate and an adjustable-rate mortgage?

A fixed-rate mortgage and an adjustable-rate mortgage (ARM) are two common types of home loans, each with distinct features. Here are the key differences between these two mortgage types:

Fixed-Rate Mortgage:

1. Interest Rate Stability:

   • With a fixed-rate mortgage, the interest rate remains constant for the entire term of the loan. Your monthly principal and interest payments do not change.

2. Predictable Monthly Payments:

   • Fixed-rate mortgages provide predictability and stability in your monthly housing costs, making budgeting easier.

3. Long-Term Planning:

   • Fixed-rate mortgages are suitable for borrowers who plan to stay in their homes for an extended period, as they offer protection against rising interest rates.

4. Higher Initial Interest Rate:

   • Fixed-rate mortgages typically have higher initial interest rates compared to the initial rates of ARMs. However, this rate remains fixed for the entire loan term.

5. Interest Rate Risk:

   • Borrowers with fixed-rate mortgages are not affected by changes in market interest rates. If market rates rise significantly, fixed-rate borrowers benefit from their locked-in lower rate.

6. Loan Term Options:

   • Fixed-rate mortgages are available with various loan terms, such as 15, 20, or 30 years. Shorter loan terms usually have lower interest rates but higher monthly payments.

Adjustable-Rate Mortgage (ARM):

1. Variable Interest Rate:

   • ARMs have an initial fixed-rate period, typically ranging from 3 to 10 years, during which the interest rate remains constant. After this initial period, the interest rate adjusts periodically based on a specific index, such as the U.S. Prime Rate or the London Interbank Offered Rate (LIBOR).

2. Lower Initial Interest Rate:

   • ARMs often offer lower initial interest rates compared to fixed-rate mortgages. This can result in lower initial monthly payments and make homeownership more affordable for some borrowers.

3. Interest Rate Adjustments:

   • After the initial fixed-rate period, the interest rate on an ARM can adjust annually, semi-annually, or at other specified intervals. The rate adjustments are subject to caps and limitations defined in the loan agreement.

4. Interest Rate Risk:

   • Borrowers with ARMs face the risk of rising interest rates, which can lead to higher monthly payments. However, if market rates remain stable or decline, borrowers may benefit from lower payments.

5. Shorter Time Horizon:

   • ARMs are often chosen by borrowers who plan to sell or refinance their homes within the initial fixed-rate period. They provide flexibility for borrowers who expect changes in their financial situation or housing plans.

6. Hybrid ARMs:

   • Some ARMs have a hybrid structure with an initial fixed-rate period (e.g., 5/1 ARM or 7/1 ARM). The first number represents the initial fixed-rate period, while the second number indicates how frequently the rate adjusts after that period.

Choosing between a fixed-rate mortgage and an ARM depends on your financial goals, risk tolerance, and how long you plan to stay in your home. If you value stability and plan to remain in your home for the long term, a fixed-rate mortgage may be the better choice. On the other hand, if you expect to sell or refinance within a few years or prefer lower initial payments, an ARM might be more suitable. It's essential to carefully consider your financial situation and consult with a mortgage professional to make an informed decision.