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Choosing a Fixed Rate or Adjustable Rate Mortgage

Interest rates come in two basic types: Fixed and Adjustable Rate Mortgage (ARM).

  • Whether your interest rate can change
  • Whether your monthly principal and interest payment can change and its amount
  • How much interest you will pay over the life of the loan

Your monthly payments are more likely to be stable with a fixed-rate loan, so you might prefer this option if you value certainty about your loan costs over the long term. With a fixed-rate loan, your interest rate and monthly principal and interest payment will stay the same. Your total monthly payment can still change—for example, if your property taxes, homeowner’s insurance, or mortgage insurance might go up or down.

Understanding Adjustable-Rate Mortgages (ARMs)

Adjustable-rate mortgages (ARMs) offer less predictability but may be cheaper in the short term. You may want to consider this option if, for example, you plan to move again within the initial fixed period of an ARM. In this case, future rate adjustments may not affect you. However, if you end up staying in your house longer than expected, you may end up paying a lot more.

ARMs are described using a certain format. Most ARMs have two periods. During the first period, your interest rate is fixed and won’t change. During the second period, your rate goes up and down regularly based on market changes. Most ARMs have a 30-year loan term.

Here's how an example 5/1 ARM would work. The first number, 5, is the number of years your initial interest rate will stay fixed. The second number, 1, is the how often your rate will adjust after the fixed period ends. Common fixed periods are 3, 5, 7, and 10 years. The most common adjustment period is 1, meaning you will get a new rate and new payment amount every year once the fixed period ends.

ARMs can have other structures. Some ARMs may adjust more frequently, and there’s not a standard way that these types of loans are described. If you’re considering a nonstandard structure, make sure to carefully read the rules and ask questions about when and how your rate and payment can adjust.

Pros and Cons of Fixed vs Adjustable Rate Mortgages

Fixed Rate:

  • Lower risk, no surprises
  • Higher interest rate
  • Rate does not change
  • Monthly principal and interest payments stay the same

Adjustable Rate:

  • Higher risk, uncertainty
  • Lower starting interest rate
  • After initial fixed period, rate can increase or decrease
  • Monthly principal and interest payments can increase or decrease over time