Fixed Rate and Adjustable Rate Mortgages
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A fixed rate mortgage has a set interest rate for the entire term of the loan, so the monthly principal and interest payment never change. You can choose from shorter or longer terms, typically 15, 20, or 30 years.
An adjustable rate mortgage, or ARM, has a set interest rate for an initial period, and then can adjust periodically over the remainder of the loan term. The monthly principal and interest payment can change after the initial period. ARMs are typically 30 year loans but you can choose shorter or longer terms.
Frequently Asked Questions
How long is the fixed period and how frequently can the interest rate change?
You can choose from a shorter or longer fixed period and adjustment frequency. The number structure used to describe the ARM indicates the length of the fixed period and the frequency the interest rate can adjust afterward. For example, a 5/1 ARM is fixed for the first five years of the loan and then can adjust annually after.
How is the rate determined during the adjustable period?
During the adjustable period ARM’s have a set margin to a benchmark rate (the ‘index’), the LIBOR, SOFR, or the Prime Rate are common indexes. If the set margin is 2%, and the index rate is 3%, the loan interest rate will be 5%. If the index rate has risen or fallen at the next adjustment date, the interest rate can change up or down to maintain the set 2% margin.
Is there a limit to how much the interest rate can change?
ARMs typically have a maximum amount the rate can change, known as ‘caps’. An ARM with caps of 5/2/5 can change as much as 5% at the first adjustment, up to 2% each subsequent adjustment, and not more than 5% over the life of the loan.
Comparison of Fixed Rate and Adjustable Rate Mortgages
- Term length can be similar, both loans are typically available for 15, 20, or 30-year terms for example
- Fixed rate mortgages have the same interest rate for the term of the loan
- Fixed rate mortgages have the same monthly principal and interest payment for the entire term of the loan
- ARM’s have a fixed period followed by an adjustment period when the interest rate can change
- ARM’s usually have a lower rate for the fixed period than a fixed rate mortgage, for the reduced initial rate the borrower commits to a set margin throughout the adjustment period
- ARM’s rate can change following the fixed period resulting in lower or higher monthly principal and interest payments
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