Published:
November 16, 2022

Fixed Rate vs. Adjustable Rate Mortgages

Does your head hurt when you start hearing about different types of loans? Financial verbiage and jargon can make anyone want to pull their hair out.

Luckily, we are here to breakdown the two most common types of home loans you’ll likely choose between in plain English.

What are they?

Fixed rate 📐

  • Interest rate stays the same through the life of the loan.
  • Your monthly payment of principal and interest won’t change.
  • 30-year fixed-rate loan is most popular mortgage.

Adjustable rate 📊

  • Begins with a set interest rate for a specified period of time.

Key differences

  • The initial interest rate: An ARM typically has a lower initial interest rate than a fixed-rate loan. That means the monthly payment during the introductory period of an ARM is lower than the payment of a fixed-rate mortgage.
  • The interest rate over time: After the ARM’s initial rate period, the rate and monthly payment can rise. Although there’s a limit to how much your rate can increase, it can still climb considerably, potentially making the loan unaffordable. A fixed-rate mortgage has a fixed payment throughout the life of the loan, and the rate and payment won’t change unless you refinance to a different loan.
  • The down payment: ARMs usually require a slightly higher down payment of 5 percent. For some fixed-rate conventional loans, you can put down just 3 percent. Might be a deciding factor if low on cash

Pros & cons: Fixed rate 📐

Pros

  • Rates and payments remain constant.
  • Stability of payments makes monthly household budgeting easier.
  • Easy to understand, especially for first timers.

Cons‍

  • Borrowers have to refinance in order to take advantage of lower rates (costs money to refi*)
  • It could cost more in interest over the life of the loan if you secure the loan at a higher rate and you don’t refinance if rates drop.
  • It is virtually identical from lender to lender and generally cannot be customized.

Pros & cons: Adjustable rate 📊

Pros

  • It has lower rates and payments early in the loan term. Because lenders can consider the lower payment when qualifying borrowers, people can buy more expensive homes than they otherwise could.
  • It allows borrowers to take advantage of falling rates without refinancing.
  • It can help borrowers save and invest more money.
  • It offers a cheaper way to buy a house for borrowers who don’t plan on living in one place for very long.

Cons‍

  • Rates and payments can rise significantly over the life of the loan.
  • Some annual caps don’t apply to the initial loan adjustment.
  • ARMs are more complex than their fixed-rate counterparts, including features like margins, caps and adjustment indexes.

Considerations when choosing

How long do you plan on staying in the home?

If you plan to only own the house for a few years, an ARM might make more sense if you’ll sell before the adjustable-rate period begins.

How frequently does the ARM adjust?

After the initial fixed period, most ARMs adjust every year on the anniversary of the mortgage. The new rate is actually determined by the index value about 45 days before the anniversary, based on the specified index, but some adjust as frequently as every month. If that’s too much volatility for you, go with a fixed-rate mortgage.

What’s the interest rate environment like?

When rates are falling, borrowers have a decent chance of getting lower payments even if they don’t refinance.

When rates are relatively low, however, fixed-rate mortgages make more sense. Rates are currently on the rise, so ARMs will be more affordable upfront, but you might see your payments grow massively once the rate lock expires.

Can you still afford your payments if rates jump?

ARM payments vary considerably and can change significantly from year to year as market conditions shift. Experts say that when fixed mortgage rates are low, fixed mortgages tend to be a better deal than an ARM, even if you plan to stay in the house for only a few years.

*Refinancing

Expect to pay around 2 – 6% of your loan balance in closing costs, which includes:

  • Application fee: Some lenders charge an application fee due when you apply for your refinance. You must pay your application fee even if the lender rejects your refinance request.
  • Appraisal fee: Most lenders require appraisals before refinancing. Most appraisers charge $300 – $500 for their services.
  • Attorney fees: In some states, an attorney must review and file paperwork for your loan. Attorney fees can vary widely by state.

Title search and insurance: Your lender may require another title search when you refinance your loan.

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