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Adjustable-rate and fixed-rate mortgages

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The interest rate on your mortgage will either be fixed or adjustable depending on what type of mortgage you choose. A fixed-rate mortgage means the interest rate will stay the same over the entire life of the loan. You will need to pay the same amount every month until the balance is paid off in full. With an adjustable-rate mortgage, the interest rate will vary at regular intervals, which means your monthly payment will also fluctuate. Both types of home loans will help you secure a piece of property, but they come with different terms and conditions that can affect your finances. Read this article to learn more about the difference between fixed-rate and adjustable-rate mortgages.

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Yellow notepad with pen svg icon Lesson Notes:
  • An adjustable-rate mortgage (ARM) has a lower interest rate for an initial period. It will then rise or fall at regular intervals based on market conditions.
  • A fixed-rate mortgage comes with a set interest rate for the full length of the term, so your monthly payment stays the same.
  • Your choice between a fixed or adjustable-rate mortgage will depend on various factors including current market conditions, your finances and your plans for the future.

What is a fixed-rate mortgage?

A fixed-rate mortgage is a home loan with a fixed interest rate for the full loan term. Your interest rate is based on the information provided in your application, including your credit score and debt-to-income ratio, as well as the current benchmark interest rate. Your monthly payment is comprised of the principal amount owed, any interest accrued, property taxes and your homeowner’s insurance premium. As time goes on, the principal and interest portion of your monthly payment will remain the same, but more of your payment will go towards the principal as the balance goes down and you accrue less and less in interest.

When you apply for the loan, you can choose the loan term which will determine how many years it will take you to pay it off. The longer the repayment period, the more you will pay in interest. The most popular type of mortgage in the country is the 30-year fixed-rate mortgage.

While the 30-year is the most popular loan term, you can also select shorter terms such as 10, 15 or 20-year terms. Shortening the repayment period can save you money on interest over the life of the loan but will also increase your monthly payment.

Use the Ent mortgage payment calculator to see how much you will need to pay every month based on the price of your home and the terms of your loan.

What is an adjustable-rate mortgage?

An adjustable-rate mortgage is a home loan with a varying interest rate. You will need to pay back the principal amount plus interest within a set number of years, just like a fixed-rate mortgage. But the interest rate will change periodically based on the terms of the loan.

Your base interest rate is based on your financial information, like your credit score. However, the lender will adjust the rate at set intervals based on the benchmark or index interest rate.

There are two phases to the ARM repayment period. The loan will start with a fixed interest rate for a set period of time, usually the first five to 10 years of the loan. Your monthly payment won’t change during this time.

Once the fixed period ends, the interest rate will change at regular intervals as stated in your loan terms. Your monthly payment may increase after the initial period depending on the interest rate environment at that time. That’s why it’s important to understand how that may affect your monthly payments.

ARMs come with a rate cap, which means the interest rate cannot increase higher than the stated limit. Read through the terms and conditions to find the rate cap to see how high the interest rate can climb.

The length of the introductory fixed-rate period and adjustment period(s) varies based on which loan you choose. A 5/1 ARM means the interest rate won’t change for the first five years. The floating rate will then change once every year following that. A 5/5 ARM means the introductory rate won’t change for five years and the floating rate will change every five years.

When is an adjustable-rate mortgage beneficial?

These mortgages can be a great choice if you plan on moving, selling, or refinancing before the initial period is up, so you don’t have to pay the higher interest rate. If you plan on applying for an ARM, try to pay off more of the principal balance before the initial period expires to save money on interest.

Some borrowers may be hesitant to apply for an ARM because, in the past, many ARM products came with balloon payments. With a balloon payment, the remaining balance on the loan is due after just five to ten years.

What is the difference between an adjustable-rate mortgage and fixed-rate mortgage?

The main differences between an ARM and a fixed-rate mortgage include:

Monthly payments

This is the amount of money you owe on your mortgage every month. With a fixed-rate mortgage, the monthly payment will stay the same for the duration of the loan unless you decide to refinance. With an ARM, the monthly payment will be fixed during the initial period, but it will likely change once the initial period is over.

Interest rates

With a fixed-rate mortgage, the interest rate stays the same over the course of the loan. This means that your monthly payment will be predictable which may be beneficial if you plan to live in the house long-term. Fixed rates may also help provide peace of mind if you’re worried about economic conditions and a changing interest rate environment.

With an ARM, the rate will stay the same during the initial period. It will then change at regular intervals. With an ARM, the changing interest rate can increase your monthly payments over time. Since we don’t know what interest rates will look like in the future, it can be hard to predict what your monthly payment will be and budget accordingly.

Initial period for ARMs

Only ARMs come with initial periods. During this period, the interest rate on your loan will not change. It may even be lower than the rate you would pay on a fixed-rate mortgage, which can help give you more purchasing power in a high-interest-rate environment.

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Consider your financial goals

Choosing between a fixed-rate mortgage and an ARM all depends on your financial goals. If you plan on staying in the same home and paying off the loan in full by the due date, a fixed-rate mortgage to lock in an interest rate and monthly payment that works for your budget may be more appropriate for you.

 If you plan on refinancing, selling, or paying off the loan in just five to ten years, an ARM with its lower initial interest rate may be a good option to consider. Talk with one of our Mortgage Loan Officers to choose the right type of mortgage for your current situation.

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