What is the difference between fixed rate mortgages and ARMs?

Fixed rates vs. ARMs

There are many different types and variations of mortgage loans out there. One of the first decisions you will have to make about your potential mortgage loan is whether you want to obtain a fixed rate mortgage or an adjustable rate mortgage.

Fixed rate mortgage loans have constant interest rates that do not change for the life of the loan. In other words, if you start out with a 6% interest rate on your fixed rate mortgage, the interest rate will stay at 6% until the loan is paid off or you refinance the loan, regardless of fluctuating market interest rates.

An adjustable rate mortgage, on the other hand, features an interest rate that is fixed for a predetermined amount of time and then becomes an adjustable rate for the remainder of the loan term. Although adjustable rate mortgage products vary from lender to lender, the basics of these types of loans are usually very similar.

For example, a 5/1 ARM would be a loan that has a fixed rate for the first five years and then every year thereafter the loan would be subject to adjustment, based on whatever interest rate index the lender uses.

If this particular 5/1 ARM featured a 1% annual cap and a lifetime 5% cap that means that every year the interest rate would not raise or lower more than one percentage point, and over the entire life of the loan the rate would not go higher or lower than fiver percent of the original interest rate.

Although adjustable rate mortgages often have lower initial interest rates than fixed rate mortgages, there is always the potential for the interest rate to eventually become much higher. Fixed rate mortgages can offer a consistency that isn’t available with ARMs.

See our ARM vs. fixed rate mortgage calculator to see which option might be right for your financial situation.