Choosing between a fixed-rate mortgage and an adjustable-rate mortgage (ARM) is a significant decision, as each has specific characteristics that affect your monthly payments, total costs, and financial predictability.
Fixed-Rate Mortgages (FRM)
A fixed-rate mortgage means your interest rate stays the same throughout the loan's term. This stability ensures that your principal and interest payments remain constant, providing predictable monthly housing expenses.
How it Works:
- Fixed Interest Rate: The interest rate you secure at closing remains unchanged for the entire duration of the loan (e.g., 15, 20, or 30 years).
- Stable Monthly Payments: Since the interest rate is fixed, the portion of your monthly payment dedicated to principal and interest remains unchanged.
- Predictable Budgeting: This stability makes budgeting easier, as you know exactly what your core mortgage payment will be each month.
- Common Terms: The most common fixed-rate terms are 30-year and 15-year mortgages, though other terms are available.6
Adjustable-Rate Mortgages (ARM
An adjustable-rate mortgage (ARM), also known as a variable-rate mortgage, starts with a fixed interest rate for an initial period, and then the rate adjusts periodically based on market conditions.11
How it Works:
- Initial Fixed Period: ARMs begin with an introductory period where the interest rate is fixed.12 Common fixed periods are 3, 5, 7, or 10 years (e.g., a "5/1 ARM" has a fixed rate for 5 years).
- Adjustment Period: After the initial fixed period expires, the interest rate will adjust at predetermined intervals, usually every six months or once a year.
- Index + Margin: The new interest rate is determined by adding a "margin" (a fixed percentage set by your lender) to a specific "index" (a benchmark interest rate that fluctuates with market conditions, like the Secured Overnight Financing Rate - SOFR, or a Treasury Index).13 So, your rate = Index + Margin.
- Rate Caps: ARMs typically have caps that limit how much the interest rate can change:
- Initial Adjustment Cap: Limits the first adjustment after the fixed period.
- Periodic Adjustment Cap: Limits subsequent adjustments (e.g., annually).14
- Lifetime Cap: Sets the maximum (and sometimes minimum) interest rate the loan can ever reach over its entire term.15
- Loan Naming: ARMs are often named with two numbers, like "5/1 ARM" or "7/6 ARM".16 The first number indicates the length of the initial fixed-rate period (in years). The second number indicates how often the rate will adjust after the fixed period (e.g., "1" for annually, "6" for every six months).
Which One is Right for You?The choice between a fixed-rate and adjustable-rate mortgage depends heavily on your financial situation, risk tolerance, and long-term plans for the home
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