The main difference between an Adjustable Rate Mortagage (ARM) and a Fixed-Rate Mortgage is the interest rate. An ARM has an interest rate that changes over time, while a Fixed-Rate Mortgage has an interest rate that stays the same over the life of the loan. If you are looking for more information on the distinction between these two loan types, read on!
ARM vs. Fixed-Rate Mortgages: What Are the Differences?
With a Fixed-Rate Mortgage, your monthly payments will stay the same, no matter what happens to interest rates. With an ARM, your interest rate will go up or down, depending on market conditions.
Another difference is that, with an ARM, you may have to pay mortgage insurance if you put down less than 20% when you buy your home. With a Fixed-Rate Mortgage, you’ll never have to pay mortgage insurance, no matter how much you put down.
One similarity between ARMs and fixed-rate mortgages is that you’ll have to pay closing costs when you take out either type of loan.
Here are other ways ARMs and Fixed-Rate Mortgages may differ:
1 – Margins
An ARM usually has a lower margin than a fixed-rate mortgage, which means the interest rate could go up or down – depending on the index – by a smaller amount than the margin on a fixed-rate mortgage.
2 – Caps
Caps help protect you from large interest rate changes. Most ARMs have periodic interest rate caps that limit the amount of interest rate increase and payment increase allowed at each adjustment interval.
3 – Interest Rate Adjustments
An ARM can adjust when your interest rate changes and your payment adjusts – depending on the index.
4 – Fixed-Rate Periods
An ARM can have a fixed-rate period anywhere from one to 10 years. After that, the interest rate and payment can adjust, depending on the index.
5 – Interest Rate
An ARM has an interest rate that could change, while a Fixed-Rate Mortgage has an interest rate that will stay the same.
6 – Payment
The payment on an ARM could change, while the payment on a Fixed-Rate Mortgage will stay the same.
7 – Index
The index is the benchmark against which the interest rate on your ARM will be measured. The most common index is the London Interbank Offered Rate or LIBOR.
8 – Interest Rate Discount
An ARM may have a lower interest rate than a Fixed-Rate Mortgage for the first year of the loan.
9 – Interest Rate Risk
An ARM has interest rate risk, which means that the interest rate on your loan could change. A Fixed-Rate Mortgage has no interest rate risk.
Now you know the key differences between an ARM vs. Fixed-Rate Mortgage. Remember, a fixed-rate mortgage has a fixed interest rate, which won’t change no matter how much the prime rate changes. An Adjustable-Rate Mortgage has a variable interest rate. It changes based on the current prime rate. It’s important to look at your financial situation and decide what option makes the most sense for you. If you’re not sure, you can always consult with a mortgage professional.
If you are interested to buy a home in Southern California, come to Century City Realtors. We have comprehensive experience across the southern California market. We handle all types of real estate transactions, including: residential, commercial, industrial, multifamily, and development.