Fixed-Rate Mortgage
What is it?
A fixed-rate mortgage has an interest rate that stays the same for the entire term of the loan (usually 15, 20, or 30 years). Your monthly payment of principal and interest will not change.
Pros
-
Predictable payments: Your monthly principal and interest payments stay the same, making it easy to budget.
-
Protection from rising interest rates: Even if market rates increase, your rate (and payment) stays the same.
-
Simplicity: Easy to understand and plan for—no surprises down the road.
Cons
-
Higher initial rates: Typically, the starting interest rate is higher than that of an ARM.
-
Less flexibility: If rates go down, you’re stuck with your original higher rate unless you refinance (which may involve costs).
Adjustable-Rate Mortgage (ARM)
What is it?
An adjustable-rate mortgage has an interest rate that can change (adjust) at set intervals after an initial fixed period. For example, a 5/1 ARM has a fixed rate for the first 5 years, then adjusts every year.
Pros
-
Lower initial rate: Usually starts with a lower rate than a fixed-rate mortgage, so your early payments may be lower.
-
Potential to save if rates fall: If interest rates decrease, your payments might get even lower after the adjustment period.
-
Good for short-term ownership: Makes sense if you plan to move or refinance before the adjustable period begins.
Cons
-
Uncertainty: Payments can increase significantly if interest rates go up after the initial period.
-
Complexity: Terms, caps, and adjustment schedules can be confusing.
-
Potential for payment shock: If rates rise sharply, your monthly payment may jump, straining your budget.
Quick Summary Table
| Feature | Fixed-Rate Mortgage | Adjustable-Rate Mortgage |
|---|---|---|
| Initial Rate | Higher | Lower |
| Payment Stability | Very stable | Can change after fixed period |
| Best For | Long-term homeowners | Short-term owners or those expecting lower rates |
| Risk Level | Low | Higher (risk of rates going up) |
| Complexity | Simple | More complex |
Which should you choose?
-
Fixed-rate is best if you value predictability and plan to stay in your home for a long time.
-
ARM can be beneficial if you need lower payments up front and don’t plan to keep the loan long term, but you must be comfortable with the risk of rising payments.