What’s the difference between a fixed-rate and an adjustable-rate mortgage?
Fixed-rate mortgages feature a steady interest rate, which is determined when you’re approved for a mortgage. This rate remains the same for the entire term of the loan. With adjustable-rate mortgages (ARMs), the interest rate may vary over the life of the loan.
There are many different ARMs. Interest rates are detemined by different indexes, depending on the lender and the loan program. These indexes are not controlled by the individual bank. Some examples are: average rate of matured treasury securities, the LIBOR or London Interbank Offered Rate (a rate banks charge each other), etc. The ARM interest rate is the index rate plus some fixed margin. You can ask your lender for the history of the index they use. Some indexes are more volatile than others, meaning they can go up or down faster than less volatile indexes. ARM’s also usually have a maximum and minumum rate regardless of the index. Rates can change monthly, yearly or at other intervals.
There are also hybrids. Typically, the interest rate is fixed the first 1 to 10 years and then adjusts or ‘resets’ at pre-determined intervals — usually once a year. For example, a 5/1 ARM will offer a lower, unchanging interest rate for the first 5 years of its term before adjusting every year. Every time your ARM’s rate adjusts, your monthly payments may increase or decrease depending on the current rate environment.
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