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Getting a mortgage can be confusing, especially when you're trying to compare all the different types of mortgage loans that are available. One fundamental decision you have to make as a mortgage borrower is whether to go with a fixed-rate mortgage or an adjustable-rate mortgage, or ARM. If you want a lower initial interest rate, then an ARM is an appealing choice. But unlike fixed mortgages, ARMs can see their interest rates move up or down over time, changing as prevailing rates in the market move. That introduces variables that can be hard to analyze, but this mortgage calculator can help you make a smarter decision about whether a fixed-rate mortgage or an ARM is better for you. Let's take a closer look at the calculator and how it can help you figure things out.


* Calculator is for estimation purposes only, and is not financial planning or advice. As with any tool, it is only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or a tax professional.

Dealing with rising rates

The tough part of comparing ARMs and fixed-rate mortgages is that the analysis requires you to predict the future. Even the best calculator can't know what will happen with interest rates in the years to come, and so you have to make smart assumptions about what could happen to rates over the course of a 30-year mortgage term.

However, there are some simple scenarios that can give you a good idea of how various situations might work. For instance, say that interest rates remain relatively stable throughout the term of the mortgage loan. In that case, the ARM will typically give you the better result, because you can usually get a lower rate on the ARM than you will on the fixed-rate mortgage. If that lower rate stays lower throughout the full 30 years, then you'll save a substantial amount. Moreover, if rates fall, then the adjustable-rate mortgage is an even better deal, because unlike a fixed mortgage, the ARM can see its rate go down.

Tougher to assess is a situation in which mortgage rates rise. In this case, a lot depends on the speed of the increase and just how far the rate goes up. The faster and larger the rise, the more advantage a fixed mortgage has over an ARM.

An example of comparing ARMs and fixed-rate mortgages

To see how this works, say that you want to borrow $200,000 toward buying a home. At the time you're looking, a fixed-rate mortgage for 30 years is available at a 4% interest rate. Alternatively, you could take out a 1/1 ARM that has a fixed 3% interest rate for the first year and then adjusts every year after that. Say that the rate can rise as much as half a percentage point every year, with an overall maximum of 8% during the lifetime of the loan.

Under this set of assumptions, the fixed-rate mortgage produces big cost savings. The initial monthly payment for the ARM is $843, compared to $955 per month for the fixed-rate mortgage. But under these assumptions, the ARM's rate rises to 8% by the 10th year of the mortgage. That boosts the monthly payment all the way up to $1,388.

The above analysis just looked at the direct costs of the mortgages without taking into account the time value of being able to make smaller payments. If you assume a reasonable return on money put toward investment rather than going toward making mortgage payments, then the differences in each situation are amplified. In other words, the value of choosing the ARM in a flat- or falling-rate environment is even greater, and the advantage in picking a fixed-rate mortgage when rates are rising is also that much larger.

Paying for certainty

No one can know what rates will do, but running some scenarios can help give you a sense of what the potential outcomes would be. In the end, a lot depends on whether you can afford to be wrong about the future direction of rates. If you won't be able to afford your monthly payment if rates rise, then picking a fixed-mortgage can be a smarter move, even if the expectation is that it will cost you more money under the most likely situations. Avoiding that risk by paying a bit more is worth the cost to many.

Choosing between fixed-rate and adjustable-rate mortgages requires a tolerance for interest rate risk. By being aware of the likely outcomes, you can fully understand what's at stake and make a decision that's best for you and your situation.

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