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Mortgage 101: ARM vs Fixed-Rate

Jun 17, 2020
How an ARM vs. fixed-rate could affect your monthly payment

There’s a lot to think about when it comes to choosing the right home loan. One important factor to consider is your type of interest rate. To determine which type might be best for you, it’s important to first understand the differences between adjustable-rate mortgages (ARMs) and fixed-rate conventional mortgages.

Interest rates on ARMs vs. fixed-rate mortgages

The biggest difference between ARMs and fixed-rate mortgages is how interest works. An ARM is set at an introductory rate and has variable increases where the rate can change over a specified period of time. This means your interest rate can fluctuate both up and down. A fixed-rate mortgage is locked in at a set rate, which stays fixed for the life of the loan.

Most fixed-rate mortgages are for periods of 15, 20 or 30 years. For example, if you were to lock in an interest rate of 4.25% on a fixed-rate mortgage, you would pay that exact interest rate for the entire period of the loan. This means you know exactly what your monthly principal and interest payment will be because your interest rate is locked in for the life of the loan.

Some borrowers, like first-time homebuyers, may choose an ARM because their interest rate starts lower versus a fixed-rate mortgage. This initial rate generally stays the same for a few or several years, depending on the type of ARM loan. When that ARM introductory period is over, interest rates will change and may result in a higher monthly principal and interest payment.

The index and your ARM monthly payment

The interest rate you pay is tied to a published benchmark of rates called an index. Your principal and interest payment go up when this index of rate increases. When interest rates decline, your payment may go down, but that is not necessarily true for all ARMs. Some ARMs set a cap on how high an interest rate can go and/or have a floor that limits how low an interest rate can go.

The Consumer Financial Protection Bureau (CFPB) recommends you make sure you know how your ARM will adjust before committing to an adjustable-rate mortgage and ask the following questions:

  • How high your interest rate and monthly payments can go with each adjustment?
  • How frequently will your interest rate adjust?
  • How soon could your payment go up?
  • Is there a cap on how high your interest rate could go?

The CFPB also recommends asking the following when considering if an ARM is right for you:

  • Can your loan balance increase?
  • Does the loan have a floor rate?
  • Does the loan have a prepayment penalty?

Regardless of what loan type you choose, it’s important to understand how your interest rate will affect your monthly payment in the long run. Work with your local Motto Mortgage loan originator to get these questions answered and to learn more about what might be right for you.

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