Fixed vs. Adjustable Rate Mortgage: Know the Difference

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Point of Interest

Choosing between a fixed- or adjustable-rate mortgage is a major that prospective homebuyers face. The right choice for you depends on your risk tolerance and long term financial goals.

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A mortgage gives individuals or families the ability to finance the purchase of a home, which is then paid off over time. Homebuyers face a key decision when searching for mortgages: ARM vs. fixed. ARM, or adjustable-rate mortgages, are mortgage loans that are subject to interest rate changes after a period of fixed interest at the start of the loan. Fixed-rate mortgages, on the other hand, offer homeowners a consistent interest rate that does not fluctuate. Both have benefits and drawbacks — the type of mortgage you choose should line up with your own financial goals and lifestyle.

Defining fixed and adjustable-rate mortgages

Fixed-rate mortgages 

A fixed-rate mortgage is a home loan with an interest rate that doesn’t change over the life of the loan. For each monthly payment, the amount you pay in interest and the portion you pay of the principal loan balance stays the same. Fixed-rate mortgages are typically more popular because they offer predictability, making it easier to manage your cash flow and budget.

With that said, lenders usually charge a higher interest rate for a fixed-rate mortgage vs. ARMs. Plus, if interest rates fall, homeowners with fixed-rate mortgages have to refinance and pay costs like origination fees to take advantage of the lower rate.

A fixed-rate mortgage makes sense for someone staying in their home for the foreseeable future with a stable income.

Tip: Your payments can change even with a fixed-rate mortgage — but only if your homeowner’s insurance payments or property taxes fluctuate.

Adjustable-rate mortgages

The main difference between fixed vs. ARM is the interest rate. Adjustable-rate mortgages begin with a specific interest rate for a set period of time. Once that fixed period is over, the interest rate can adjust once per year, raising or lowering your payments. Some ARMs set caps on how much your interest rate can increase or decrease each year from the year prior.

A homebuyer might want to consider an ARM if they expect their earnings to increase over time and can afford potentially larger mortgage payments. Short-term homeowners who plan to move before the initial interest rate period resets may also want to consider an ARM.

Fixed vs. adjustable: pros and cons

Pros/ConsFixed-Rate MortgageAdjustable-Rate Mortgage
Pros-Identical monthly payments
-Easier budgeting
-Straightforward financing
-Less expensive upfront
-Not necessary to refinance
-Great for short-term homeowners
Cons -Interest rates could fall
-Harder to shop around
-Might be costlier
-Rates and payment changes
-ARMs are more complex
-Annual cap caveats

Comparing fixed and adjustable-rate mortgages

Fixed-rate mortgages are usually 15- or 30-year loans. The interest rate never changes, although you’ll likely be paying a higher interest rate at the onset compared to ARMs. For your down payment, the industry standard is at least 20%. If you don’t hit the 20% down payment minimum, you’ll need to pay for private mortgage insurance, which can be a costly addition to your mortgage.

To qualify for a fixed mortgage, you’ll need a credit score of about 620. However, mortgage lenders often have their own specific qualifications for approval, so the lender requirements could be much higher than 620 depending on who you go with.

Adjustable-rate mortgages are enticing because they feature lower interest rates at the onset of the loan, which is a major draw for first-time homebuyers. There are a few different types of adjustable-rate mortgages: 5/1 ARM, 7/1 ARM and 10/1 ARM.

The first number in each of these ARMs — so the 10 in 10/1 or the 7 in 7/1 — refers to the initial interest rate period and how long it will last. The second number is how often the interest rate can fluctuate. The most common ARM is a 5/1 ARM, which features a fixed interest rate for the initial five years of the loan. Then, the rate adjusts each year for the remaining 25 years of the loan.

As with conventional fixed-rate mortgages, ARM lenders have their own requirements for getting approved. ARM lenders will typically accept lower credit scores compared to conventional mortgage lenders, but that may also depend on other factors like your debt-to-income ratio and income.

Deciding between these two types of mortgages comes down to risk tolerance, your long term plans and your financial situation. If you’re moving soon or you expect a significant increase in your income over time (perhaps you’re a young doctor or lawyer who’s at the beginning stages of your career), then an ARM might be a good bet. Otherwise, fixed-rate mortgages boast predictability to homeowners looking to settle down. Compare national mortgage rates to see how every mortgage type stacks up against each other.

The final word

When you’re deciding between an ARM vs. fixed mortgage, consider your own financial situation to help guide your choice. Although fixed-rate mortgages are more popular because of their longterm predictability, ARMs can offer serious savings for the right homebuyer. Ultimately, your mortgage choice should reflect your risk tolerance, how long you plan to stay in your home, your earning potential and overall budget.

Michelle Wilson

Contributing Writer

Michelle Wilson is a San Diego-based writer specializing in unraveling the mysteries of personal finance and technology.