What is the difference between a fixed-rate and adjustable-rate mortgage (ARM) loan?
With a fixed rate mortgage, the interest rate is set when you take out the loan and will not change.
With an adjustable rate mortgage (ARM), the interest rate may go up or down. Many ARMs will start at a lower interest rate than fixed rate mortgages. This initial rate may stay the same for months or years. When this introductory period is over, your interest rate will change and the amount of your payment will likely go up.
Part of the interest rate you pay will be tied to a broader measure of interest rates, called an index. Your payment goes up when this index of interest rates moves higher. When interest rates decline, sometimes your payment may go down, but that is not true for all ARMs. Many ARMs will limit the amount of each adjustment, and set a maximum or “cap” on how high your interest rate can go over the life of the loan. Some ARMs also limit how low your interest rate can go.
TIP: Know how your ARM adjusts. Before taking out an adjustable rate mortgage, find out:
- How high your interest rate and monthly payments can go with each adjustment
- How frequently your interest rate will adjust
- How soon your payment could go up
- If there is a cap on how high your interest rate could go
- If there is a limit on how low your interest rate could go
- If you will still be able to afford the loan if the rate and payment go up to the maximums allowed under the loan contract
TIP: Don't assume you’ll be able to sell your home or refinance your loan before the rate changes. The value of your property could decline or your financial condition could change. If you can’t afford the higher payments on today’s income, you may want to consider another loan.