Choosing between a Fixed-rate mortgage and adjustable-rate mortgages (ARMs) is one of the first decision you have to make in the mortgage process. It’s important to know the difference between these two categories to determine which loan types best fits your financial needs.
The interest rate and monthly payments of the traditional 30-year fixed-rate mortgage never changes. If you obtain a loan with 5%, you will pay the 5% interest until the loan is fully paid off. Different loan terms are available with 15 and 30-year terms being the most popular.
Adjustable-rate mortgages, also commonly referred to as “ARMs” have interest rates that may change one or more times during the life of the loan. There are usually limits to how much a rate can change in an adjustment period. Although ARMs are often initially made at a lower interest rate, the rate can potentially exceed the standard fixed rates depending on the market condition and the structure of the loan.
As a borrower, you have to carefully weigh the pros and cons associated with these types of mortgages. The ARM loans may start off with a lower rate than the fixed-rate loans, but the rate and monthly payments can rise over time. In comparison, the rate and monthly payments never change for the fixed-rate loans, but you may have to pay higher interest charges for the stability.
Typically, many borrowers who plan to stay in the home for many years choose the fixed mortgage for the security. If the interest rate drops in the future, they will also have the option to refinance. A borrower who decides on an ARM at a low-interest rate can benefit by paying less monthly payment initially, but it comes at a price of the uncertainty of the adjustment period.