Choosing the right mortgage can have a major impact on the cost of buying a home. Two common mortgage structures in the United States are fixed-rate mortgages and adjustable-rate mortgages, often called ARMs.
Understanding how these two options work can help prospective homeowners compare financing terms and determine which structure fits their financial situation.
What Is a Fixed-Rate Mortgage?
A fixed-rate mortgage has an interest rate that generally remains the same throughout the agreed loan term.
Because the rate does not change, the principal and interest portion of the monthly payment is generally predictable. This can make long-term budgeting easier.
For example, if a borrower takes out a 30-year fixed-rate mortgage, the interest rate established at closing generally remains unchanged for the entire loan.
However, the total monthly housing payment can still change if property taxes, homeowners insurance, or other escrow costs change.
What Is an Adjustable-Rate Mortgage?
An adjustable-rate mortgage starts with an interest rate that is fixed for an initial period and may then adjust according to the terms of the loan.
An ARM may be described using numbers such as 5/1 or 7/1. The first number generally represents the number of years the initial rate remains fixed, while the second number indicates how frequently the rate can adjust afterward.
The specific adjustment rules depend on the mortgage agreement.
How ARM Adjustments Work
After the initial fixed period, an ARM’s interest rate can change based on an underlying index plus a lender-set margin.
Most ARMs also have limits on how much the rate can increase or decrease during an adjustment period and over the life of the loan.
These limits are commonly known as caps.
Because future interest rates cannot be known with certainty, borrowers considering an ARM should understand the maximum possible payment under the loan’s terms.
Comparing Monthly Payments
A fixed-rate mortgage can provide more predictable principal-and-interest payments.
An ARM may initially have a lower rate than some fixed-rate options, but the future rate can change after the introductory period.
The important question is not simply which loan has the lower starting rate.
Borrowers should consider how long they expect to own the home, their ability to handle potential payment increases, and the complete terms of the mortgage.
Which Mortgage Should You Compare?
There is no single mortgage structure that works for every borrower.
Someone planning to remain in a home for many years may place significant value on payment predictability.
Another borrower who expects to move or refinance before an ARM’s initial fixed period ends may evaluate the introductory rate differently.
However, future plans can change, so borrowers should understand the risks rather than assuming a refinance or home sale will definitely happen.
What to Check Before Choosing
Before accepting a mortgage offer, review:
- Interest rate
- APR
- Loan term
- Monthly principal and interest
- Closing costs
- ARM adjustment periods
- Interest-rate caps
- Prepayment terms
- Estimated total borrowing cost
Comparing these details across multiple lenders can make it easier to understand the differences between offers.
Final Thoughts
Fixed-rate mortgages and adjustable-rate mortgages have different structures and risks.
A fixed-rate mortgage generally provides greater payment predictability, while an ARM can have a changing interest rate after its initial fixed period.
The right choice depends on the borrower’s finances, expected time in the home, tolerance for payment changes, and the specific loan terms available.
Mortgage rates and lender requirements change over time, so borrowers should review current offers and the complete loan agreement before making a decision.