ARM vs. fixed rate mortgages: What’s the difference?

An adjustable-rate mortgage, better known as an “ARM,” is a home loan with an interest rate that can change periodically. Your monthly payments will go up or down when interest rates fluctuate.

An ARM starts with an introductory fixed interest rate, then adjusts after the initial fixed interest rate period ends. The rate can change based on the index agreed to in terms. Period terms are set up in advance and range between 3-, 5-, 7- and 10-year terms. This differs from a fixed rate in that a fixed-rate mortgage has the same interest rate for the entire term of the loan.

ARM advantages

• Generally, lower initial interest rates than a fixed-rate mortgage
• Start with lower up-front payments
• Shorter loan terms, which may be beneficial if you will not be in your home long
• Caps limiting the amount by which rates and payments change, protecting you from potential steep increases

ARM disadvantages

• Rates and payments can rise over the life of the loan
• Long-term budgeting becomes difficult once an adjustable loan moves into the adjustable phase
• Potential prepayment penalties
• ARMs may be challenging to understand

Before taking out an ARM, the Consumer Financial Protection Bureau recommends asking your lender questions about how your ARM adjusts, such as how frequently your interest rate will change and if there’s a limit on how low your interest rate could go. If you’re afraid of increases in your mortgage, it may be better to go with a fixed rate which will give you the same payment and interest rate throughout the term of the loan.

Are you planning to move or refinance in 5-10 years? Because an ARM’s initial fixed-rate periods range from 3-10 years, this type of mortgage might be a good fit for you. An ARM could also be the right choice if you’re interested in a lower initial payment and are comfortable with future up or down rate changes.

A fixed-rate mortgage loan is a loan where the interest rate remains the same for the entire term of the loan, resulting in a fixed payment amount that will not change. Interest rates are locked up-front, allowing borrowers to predict their future payments accurately. Loan lengths vary, but the most common term is 30 years.

Fixed-rate mortgage advantages

• Rates and payments won’t change, even if inflation increases and interest rates rise
• Payment stability makes budgeting your finances easier
• 10-30 year loan terms, which may be beneficial if you plan to stay in your home for a longer period
• Simple to understand for first-time homebuyers

Fixed-rate mortgage disadvantages

• To take advantage of falling rates, fixed-rate mortgage holders have to refinance
• Because the payments over the first few years primarily go toward interest, it may take longer to pay off the principal than an ARM

Before taking out a fixed-rate loan, the balance recommends asking your lender about the interest rate and annual percentage rate as well as a loan estimate containing all of the costs of your loan.

Are you planning on keeping your home for ten years or more and need the predictability of a fixed payment? Fixed-rate mortgages are particularly popular with first-time homebuyers with adequate credit and anyone who finds it easier to budget and plan around constant rates and payments. Also, a wide range of conventional and government (FHA, VA and USDA) loan options are available.