What's the Difference Between a Fixed Rate and an Adjustable Rate Mortgage?

Buying a home is overwhelming - plain and simple. There are just so many decisions to make. When is a good time to buy? What neighborhoods are on the upswing? How old is too old? How much is too much? Are we truly fixer-upper kind of people? How badly do we need a fenced yard? Do the neighbors look friendly? More importantly, do they look quiet? Which lender is the best? What in the world is an adjustable rate mortgage? Is this really worth all the stress?

Okay, let’s slow it down and tackle those questions one at a time, starting with the easiest: Yes, it really is worth all the stress.

Next, we’ll jump up a level and work through a tougher one: the world of adjustable rate mortgages. But before we go too deep, let’s look at its counterpart – the fixed rate mortgage – because to understand one, you have to understand the other.

Fixed Rate Mortgages

The fixed rate mortgage is just that – a mortgage that has a fixed interest rate, one that does not change over the life of the loan. Whether it be 10 years or 30, that interest rate is going to stay the same.

For homebuyers who prefer to stay on-budget, tend to avoid financial risk, or plan to stay in the home for at least five years, the fixed rate mortgage is most likely the best bet. While the interest rate might be higher than the initial percentage offered on an adjustable rate mortgage, over the life of the loan, homeowners tend to pay a considerable amount less in interest. Additionally, this route allows the buyer to build a budget and stick to it as the payment amount never changes (not withstanding any escrow payments that could fluctuate due to property taxes or insurance costs).

Those looking for consistency in their monthly expenditures and a bit more peace of mind in the homebuying process will do well to consider this type of loan. Fixed rate mortgages are dependable, reliable, steadfast – much like that trusty dog laying by your side, the one you just have to get a fenced yard for, right? Seriously. There are so many questions.

Adjustable Rate Mortgages (ARMS)

So back to the big one: What in the world is an adjustable rate mortgage? Let’s start with the basics. An adjustable rate mortgage (ARM), also commonly referred to as a variable rate mortgage, is a loan in which the interest rate is subject to change after a fixed number of years. This type of loan usually begins at an attractively low rate for the initial period (typically 3, 5, 7 or 10 years) after which time the interest rate adjusts annually or even monthly based on the index it is tied to.

These types of mortgages often appeal to buyers planning to sell the home prior to the end of the initial fixed period, those hoping for more house than their current debt-to-income ratio allows, or folks purchasing a second home for the purpose of future rental income to help offset the increase in payment amounts. An ARM can be a great option for buyers with specific goals like these, but like all methods of financing, it is important to do ample research before laying down any signatures. To better understand how variable rates are determined, organizations like Debt.org are available to fill in the blanks. Mortgage calculators designed to help consumers considering variable rate loans are also a handy tool.

Financing a home is a big deal, and the decision on which type of mortgage to pursue plays a key role in how quickly and comfortably you can pay down that debt. For this reason, be sure to take your time, plug in the numbers and ask great questions of your lender before making the final decision. An adjustable rate mortgage might just be the ticket, but much like those seemingly serene neighbors, looks can be deceiving. In five years, that quiet couple might have four barking dogs, two sets of twins, a new affinity for the drums and a rooster that crows from sun up to midnight – and that’s okay as long as you had the foresight to plan for the increase in volume, as long as you’ve prepped during the honeymoon period and stocked up on ear plugs. An adjustable rate mortgage is kind of like that, a perfectly suitable option for those who are well-prepared.