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By Selena Maranjian (TMF Selena)
July 19, 2002

Q. What's the difference between fixed-rate and adjustable-rate mortgages?

A. These are the two main types of mortgages -- the Coke and Pepsi, the cats and dogs, the salt and pepper (you get the idea) -- of the home-lending world.

A fixed-rate mortgage is very straightforward. The borrower knows from the beginning what the interest rate will be for the entire duration of the mortgage, and the monthly payments due are likewise fixed. Simple.

Slightly less simple is the adjustable-rate mortgage (ARM). Its rate changes from year to year, to reflect the interest rate environment. If rates are plummeting, your rate will also drop -- and vice versa. ARMs typically have an extra-low "teaser rate" for the first year, as well as an upper limit, or cap. In addition, the amount that an ARM rate can rise each year is also limited, so that it won't rise too quickly.

Fixed-rate mortgages are good because they come with no surprises. But, for this benefit, you'll likely pay a slightly higher rate than you would with an ARM. Fixed-rate mortgages are good for people who enjoy stability. They're also especially attractive during periods when interest rates are low, like in recent years. At such times, fixed-rate mortgages permit you to lock in low rates for many years.

Conversely, if the prevailing interest rates are high, an ARM might make more sense, if you think rates are more likely to fall than rise. In addition, since ARM rates are typically slightly lower than fixed rates, they permit borrowers to borrow a little bit more. This difference can help you buy a slightly spiffier house. ARMs are often recommended for those who will only be in a house for a few years -- as the rate is not likely to change much in that time. But beware -- don't enter into an ARM unless you're sure you'll be able to handle the worst-case scenario: Your rate might quickly rise to the cap.

Click over to our online calculators, which can answer such questions as, "Which is better: fixed or adjustable?"

You can learn more about home buying in our Home Center -- we've even got good deals on mortgage rates and information on refinancing.

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This question and answer is adapted from The Motley Fool Money Guide: Answers to Your Questions About Saving, Spending and Investing. For answers to this and 499 other common money questions, check it out -- it's a handy resource.