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Fixed Mortgages vs. ARMs

Fixed-rate and adjustable-rate mortgages are the two main types of mortgages of the home-lending world. Let's take a look at the differences.

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. By far, the most popular fixed-rate mortgage is the 30-year mortgage, but you can also get 15-year loans easily, and some banks offer other terms as well. Simple.

The adjustable-rate mortgage, or ARM, is slightly less simple. With these mortgages, your rates will change from time to time, depending on what type of ARM you have. With a 5/1 ARM, for example, you'll have a fixed rate for the first five years, but after that, your rate will reset from year to year, depending on prevailing interest rates. 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. The amount that an ARM 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. In exchange for essentially allowing you to lock in a rate for a long period of time, however, you'll often 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. At such times, fixed-rate mortgages permit you to lock in low rates for many years to come.

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

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