What's the difference between a fixed vs. adjustable-rate mortgage?

When you’re buying a house, there are many different decisions to make – from budget and location to type of home and type of loan. One of the many decisions home buyers must make is whether they’ll choose a fixed- or adjustable-rate mortgage. Both types of mortgages come with pros and cons and key differences you’ll need to know about to help you choose the best option for your goals.

Fixed vs. adjustable-rate mortgage

The difference between an adjustable-rate mortgage vs. fixed is how the interest rate works over the life of the loan. The interest rate stays the same for fixed-rate mortgages, but with an adjustable-rate mortgage, the interest rate may fluctuate over the life of the loan.

Both types of mortgages can be a good option for borrowers, depending on their financial goals. For instance, homebuyers looking to take advantage of lower rates may be drawn to adjustable-rate mortgages.

But a fixed-rate mortgage will be a better option if you’re looking for more consistency in your monthly payments. The following table highlights the main differences between the two loan types.

What is a fixed-rate mortgage?

A fixed-rate mortgage comes with interest rates that don’t change throughout the life of the loan. Because the interest rate stays the same, your monthly payment will also remain the same, which can make budgeting easier.

Let’s say you took out a fixed-rate mortgage for $250,000 for 30 years with a 5.5% interest rate. Your monthly payment would be $1,419, not including taxes and homeowners insurance. This payment will stay the same every month, regardless of current market conditions.

Pros of fixed-rate mortgages

• Since your interest rate stays the same, your monthly payment toward your principal and interest will also remain the same.
• It’s easier to budget for expenses when you know what your monthly mortgage payment will be.
• Fixed-rate mortgages are easier to understand than adjustable-rate mortgages.

Cons of fixed-rate mortgages

• If you have a fixed-rate mortgage, you can’t take advantage of lower rates unless you refinance.
• Fixed-rate loans can be harder for borrowers with poor credit scores to qualify for.

What is an adjustable-rate mortgage?

An adjustable-rate mortgage (ARM) has an interest rate that changes periodically over the life of the loan. When you first get the mortgage, you’ll earn a low introductory rate — this rate will often be lower than what you’d receive on a fixed-rate mortgage. But once the rate period is over, your interest rate will adjust to market conditions.

Calculating your monthly payments is more challenging when you take out an ARM. For instance, there are many different types of ARMs. For example, a 5/1 ARM comes with an introductory rate for the first 5 years, and then the interest rate adjusts annually. So you can estimate your monthly payments for the first 5 years, but there’s no way to know what they’ll look like after that rate period is over.

Pros of ARM loans

• You may receive a lower interest rate initially than if you take out a fixed-rate loan.
• Borrowers can take advantage of low-interest rates without refinancing.
• These loans can be a good option if you only plan to live in the home for a short time.

Cons of ARM loans

• Your monthly payments could rise significantly once the introductory period is up.
• If you’re unable to refinance or sell your home, you may be stuck with an unaffordable mortgage payment.

Is an ARM better than a fixed-rate mortgage? How to choose which loan is right for you

When you take out a fixed-rate mortgage, your interest rate won’t change over the life of the loan. Because there’s less risk, fixed-rate loans are the most popular type of mortgage. However, you can’t take advantage of falling interest rates without refinancing.

 ARMs come with risks, but you’ll likely secure a lower interest rate in the beginning. And there are some scenarios when it could make sense to take out an ARM. For instance, if you’re not planning to stay in the home for more than 5 years, taking out an ARM and taking advantage of lower interest rates while you’re there could be a good idea.

Ultimately, the loan that’s right for you depends on your financial situation and your goals. Here are some questions to consider when deciding between the two types of mortgages:

• How long do you plan to stay in your home?
• What is your credit history like?
• Can you qualify for the lowest rates on a fixed-rate loan?
• What are interest rates expected to do in the coming years?
• If you take out an ARM, can you afford a potentially higher payment?

The bottom line

When you’re looking to buy a home, you can apply for either a fixed-rate loan or an ARM. There’s not one right answer, and either type of mortgage can make sense in different situations. It’s important to consider all your options and make the choice that’s right for you.

Regardless of the type of loan you select, the first step is to get started online today, so you can get prequalified and see what your options are.