Fixed interest rate vs. Adjustable mortgage (arm)
Fixed-rate mortgages are a go-to for most borrowers, despite charging low interest rates for adjustable rate mortgages (arms) to launch.
How a fixed-rate mortgage works
Fixed-rate mortgages (FRMs) have the same interest rate as the life of the loan, so they remain the same unless you move or refinance your monthly mortgage payments (principal and interest portions). Fixed-rate mortgages are usually offered on 30 and 15 years terms, but there are also flexible terminology options for 8 to 29 years.
Adjustable mortgage (weapon) mechanism
Adjustable mortgages have fixed rate adoption periods, usually changing at a given interval after 3, 5, 7, or 10 years. Generally, this initial fixed rate is lower than that of a standard fixed rate mortgage.
Once the introduction period ends, the rate is usually adjusted up and down for six months or annually. These adjustments are often tied to financial indices such as secured, continuous financing rates (SOFRs). Most arms have caps that limit how much your rate can increase.
The difference between fixed rates and adjustable mortgages
The biggest difference between fixed-rate mortgages and arms is the fluctuations in interest rates. With fixed-rate mortgages, interest rates change over time, while interest rates remain constant throughout the loan term. As prices go up, monthly payments increase, and vice versa.
Beyond the rate structure, the differences between fixed-rate mortgages and arms are as follows:
- Initial interest rate: Arms usually have lower initial interest rates and monthly payments than fixed-rate loans.
- Down payment minimum: In the traditional sector, a down payment of 5% should be higher than a 3% traditional fixed-rate loan.
- How to calculate interest: With a fixed-rate mortgage, your fees will be set at the start of the loan. With arms, rates are recalculated for each adjustment based on the index, lender margin, and cap associated with the arm.
Examples of fixed interest rates and arm payments
This is an example of the difference in monthly payments between a fixed-rate mortgage and an arm. In this scenario, we assumed an initial adjustment of 1.5%, followed by a 1.5% adjustment, and a lifetime rate cap of 5%. We also ruled out homeowner insurance and property taxes. Our arms and fixed fee calculators help you compare your own payment scenarios.
| 5/1 Arm (30 years) | FRM (30 years) | |
|---|---|---|
| Home prices | $390,000 | $390,000 |
| Loan amount | $370,500 (5% down) | $378,300 (3% down) |
| Initial interest rate | 6.11% | 6.89% |
| First mortgage payment | $2,248 | $2,489 |
| Maximum mortgage payments | $3,376 | $2,489 |
Similarities between fixed interest rates and adjustable mortgages
Fixed-rate mortgages and weapons have some similarities.
- Both come with standard 30-year repayment options. Both fixed-rate mortgages and weapons offer standard 30-year terms.
- Both require good credit for the most favorable terms. With either a fixed rate mortgage or arm, you need excellent credit to excellent credit to get the best rates and conditions.
- Both can be refinanced. Whether you have a fixed-rate mortgage or a division, you have the option of refinancing.
Choosing a fixed rate or adjustable mortgage
There are no correct or wrong answers for mortgages that can be adjusted at fixed rates. Both have their advantages and disadvantages. Still, one type of loan may be better than the other types due to your financial situation.
A fixed-price mortgage may be the best option:
- Someone who plans to put it – If you plan to make your next move permanent, stability in a fixed rate mortgage may be your best option. You don’t have to worry about an increase in monthly principal and interest payments. Additionally, if the fees drop, you have the option to refinance in the future.
- The first house buyer – Buying a home is a complicated process, and the nuances of the arm can make it even more difficult. Additionally, many first-time home buyer loan programs come with only a fixed rate option.
- People who get a mortgage when the fee is low – If the borrowing cost is relatively inexpensive, it may be best to lock that low fixed interest rate.
- People who save less on down payments – Traditional fixed-rate loans require only 3% down, but weapons require 5%. If you have cash, fixed-rate loans may be easier to manage on the front-end.
Your arms may be the best:
- Those who plan to move in the short term – If you plan to move in a few years, you can save money with low intro payments on your arm and leave before the rate resets.
- People who are expected to increase their income – If you can expect a significant increase in revenue over time or a financial stairwell, you may be equipped to handle the rising rates.
- People who get a mortgage when the fee is higher or more unstable – Arms can be a more attractive option if the general market rate is high or if the movement is particularly uncertain.
- People who are giving out jumbo loans – Getting more mortgage means paying more interest over time. The arm helps save this cost at least at first.
