What is the difference between a fixed-rate and adjustable-rate mortgage (ARM) loan?

What is the difference between a fixed-rate and adjustable-rate mortgage (ARM) loan?

A fixed-rate mortgage differs from an adjustable-rate mortgage (ARM) in that the interest rate is determined when the loan is obtained and remains constant throughout the loan term. In contrast, an adjustable-rate mortgage (ARM) has an interest rate that can fluctuate.

Many ARMs initially offer lower interest rates compared to fixed-rate mortgages. This introductory rate remains unchanged for several months, a year, or even several years. After this initial period ends, your interest rate and monthly payment are likely to increase.

An index, a broader measure of interest rates, influences a portion of the interest rate you pay on an ARM. When this index increases, your payment also increases. While some ARMs may lower your payment in response to declining interest rates, this is not guaranteed for all ARMs. Some ARMs have caps that limit how high your interest rate can rise and how low it can fall.

Before opting for an adjustable-rate mortgage, understand how your ARM adjusts. Consider the following:

• The maximum amount by which your interest rate and monthly payments can increase with each adjustment.

• The frequency of interest rate adjustments.

• The speed with which your interest rate could increase.

• Whether there is a maximum limit to how high your interest rate can go.

• Whether there is a minimum limit to how low your interest rate can go.

• Evaluate whether you can still afford the loan if your interest rate and payment increase to the maximum levels the loan agreement allows.

Tip: Keep in mind that selling your home or refinancing your loan before the rate adjustment may only sometimes be feasible if your financial situation changes or the value of your property decreases. Consider alternative loan options if you anticipate difficulty making increased payments with your current income.