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Many home buyers gravitate toward the traditional fixed-rate mortgage — often with 15- or 30-year terms — but home loans aren't one-size-fits-all. You may be able to get an even lower initial interest rate, and a term that's more suitable to your needs, with an adjustable-rate mortgage, or ARM.
Comparing ARM and fixed-rate mortgages will help you choose the best home loan for your current needs and future goals.
Interest on ARMs vs. fixed-rate mortgages
The biggest difference between ARM and fixed-rate mortgages is how interest works. Fixed-rate loans have interest rates that never change. ARM rates reset at specific intervals over the full loan term. Adjustable-rate mortgages can be a powerful tool for home buyers with shorter-term goals in mind, but they do have their risks.
“A fixed-rate loan has an interest rate that never changes. An adjustable-rate mortgage has rates that may go up or down on a regular basis.”
ARMs begin with a set interest rate for a specified period of time, then the rate is adjusted periodically after that. The key to knowing how an ARM will adjust is hidden in its name: A 5-year ARM, also known as a 5/6 ARM, means your rate will be fixed for five years, then adjusted every six months, for example. The most common ARM terms have initial fixed-rate periods of three, five, seven or 10 years.
Although ARM interest rates start lower than fixed-rate loan rates, there’s always a chance they will reset higher several times over the life of the loan, increasing your mortgage payment.
Example: ARM vs. fixed-rate mortgage payments
30-year fixed rate mortgage
Mortgage amount: $300,000
Mortgage amount: $300,000
Interest rate: 3.5%
Interest rate: 4.5%
Payment: $1,347.13 (after five years, this payment will reset using a new interest rate that could increase it)
Payment: $1,520.06 (this payment will never change as long as you have the same mortgage)
Is an ARM or a fixed-rate mortgage better?
If you’re settled into your career, have a growing family or are ready to set down some roots in a community you love, a 15- or 30-year fixed-rate mortgage may be right for you. With a locked-in rate, you’ll always know what your payment will be. And if rates drop or your home appreciates significantly a few years into your mortgage, you can always take advantage by refinancing into another fixed-rate mortgage at the lower rate.
“Adjustable-rate mortgages most often appeal to first-time homebuyers.”
Adjustable-rate mortgages, on the other hand, most often appeal to first-time homebuyers because lower rates boost buying power. If you’re advancing in a career that could require you to move within a few years, are thinking about starting a family, or just want to keep your long-term options open, an ARM could be a good choice. You'll get the benefit of a lower introductory rate and the flexibility to move away or trade up to a bigger home before the fixed-rate period ends.
The bottom line: ARM vs. fixed
ARMs have some appeal, especially for homeowners who want lower initial payments or relocation flexibility. You’ll want to do the math to make sure that if rates rise after the introductory period, your income can handle the higher monthly payments. But if interest rates stay low or even fall, adjustable-rate mortgages can potentially save you a lot of money. Fixed-rate mortgages may be a better choice for those who plan to stay put or need reliable mortgage payments that never change.
» MORE FOR CANADIAN READERS: Fixed vs. variable mortgages