Fixed-rate vs. adjustable-rate mortgage: Which is right for you?

It’s important to compare the pros and cons of the different types of interest rates available.

Fixed-Rate vs. Adjustable-Rate Mortgage

Whether you’re thinking of buying a new home or considering refinancing, you should always weigh your options when it comes to the type of mortgage to apply for. Many factors determine the interest rate on a particular mortgage. Some of the factors that will effect your rate include conditions in the financial markets, your mortgage type, and your credit. But first, it’s smart to compare the two basic types of mortgages to see which is the right option for you.

Fixed-rate mortgage (FRM)

A fixed-rate mortgage has an interest rate that remains the same over the entire term of the mortgage, regardless of how interest rates change in the marketplace.

Adjustable-rate mortgage (ARM)

An adjustable-rate mortgage has an interest rate that is fixed for a specific period of time and then changes on scheduled dates based on your mortgage agreement to reflect market conditions. The interest rate is based on a market index that is subject to change plus a margin that does not change (after the initial interest rate period, the interest rate can adjust up or down at regular intervals based on changes to the market index):

  • Market index: A published rate, such as the prime rate, LIBOR, or T-Bill rate.
  • Margin: The set percentage the lender adds to the index rate to determine the interest rate of an ARM.

The initial interest rate is the total of these two values plus or minus small adjustments made by the lender due to market conditions. When the initial interest rate adjusts, and at each subsequent adjustment, the interest rate will be the total of the market index and the margin, subject to any increase or decrease limitations, often referred to as “rate caps” or “rate floors.”

Comparing FRM and ARM

Mortgage type Who may benefit with this type? What are the benefits? What are the drawbacks?
Fixed-rate mortgage (FRM) Customers who finance their homes when rates are relatively low. Gives homeowners predictable principal and interest payments over the term of the loan and protects from rising rates and rising monthly principal and interest payments. Interest rate is generally higher than the initial interest rate of an ARM. If the interest rates in the market decrease, your rate will not adjust to a lower rate unless you refinance to a new mortgage.
Adjustable-rate mortgage (ARM) Customers who will move and/or sell their home before the first interest rate adjustment.

 

Those who want the ability to pay a lower monthly mortgage payment during the first year(s) of ownership.

 

Those who finance their home when fixed rates are comparatively high.

The initial rate is usually lower than a FRM, thus making initial payments lower. If your interest rate increases at adjustment, you may experience “payment shock” if your monthly payments increase to an amount you may not be able to maintain along with your other monthly obligations. If refinancing or selling is not an option, you could be at risk of losing your home.

Remember, interest rates only tell part of the story. Contact your Wells Fargo Mortgage professional with any questions or concerns you may have about interest rates or other factors that may affect your monthly mortgage payment.