Adjustable vs. Fixed Mortgages: Compare the Tradeoffs

Choosing an adjustable vs. fixed mortgage involves more than comparing today’s interest rates. Look at how each offer changes over time, whether a higher payment would fit your budget, and the total borrowing costs shown on the Loan Estimate. Neither structure is automatically the better choice for every borrower.

Adjustable vs. fixed mortgage: the basic difference

On a standard fully amortizing fixed-rate mortgage, the interest rate stays the same for the loan term, so the scheduled principal-and-interest payment generally stays the same. Your total housing payment can still change when property taxes, homeowners insurance, mortgage insurance, or escrow amounts change.

An adjustable-rate mortgage (ARM) has an interest rate that can change under the loan agreement. Many ARMs begin with a period when the initial rate is fixed, but that period is not universal. The first possible adjustment date and the frequency of later adjustments depend on the specific loan. Read the written terms rather than assuming every ARM follows the same schedule.

What can happen when an ARM adjusts?

After any initial fixed-rate period, an ARM’s rate is generally calculated from an index plus a margin, subject to the loan’s terms. An index can move with market conditions; the margin is set in the loan agreement. Initial, later, and lifetime adjustment caps may limit rate changes, while floors may limit how far a rate can fall. These features vary by loan. A cap limits a change; it does not promise that the resulting payment will be affordable.

Ask the lender to show when the first rate change can occur, how often the rate and payment may change, and the highest payment allowed under the proposed terms. For most ARMs, the payment is recalculated when the rate adjusts, but some loans handle payment changes differently. A small or delayed payment can have consequences if it does not cover the interest due, so ask whether the loan balance could increase.

Compare written offers on the same basis

Use Loan Estimates for the same loan amount and term when comparing offers. Review the principal-and-interest payment, mortgage insurance if applicable, estimated taxes and insurance, total closing costs, and cash to close. For an ARM, look closely at the projected payments and the adjustable-rate tables. Ask the lender to explain any gap between the initial payment and the payment that could apply after an adjustment.

Consider how long you may keep the loan, but do not make the decision depend on being able to sell or refinance by a particular date. A future refinance depends on rates, home value, income, credit, costs, and lender approval at that time. Compare whether your budget could handle the ARM payment if it rises under the contract. Review the Loan Estimates with a lender and ask for a written explanation of any term you do not understand.

Questions to bring to the conversation

• When can the interest rate change for the first time, and how often after that?
• Which index, margin, rate caps, and floors apply to this ARM?
• What are the estimated initial and highest possible principal-and-interest payments under the loan terms?
• Can the payment be recalculated at a different time from the rate, or can the balance increase?
• How do the Loan Estimates compare for total monthly housing cost, closing costs, and cash to close?
• Are there prepayment penalties or other features that would matter if plans change?

For more detail, read the Consumer Financial Protection Bureau’s guidance on fixed and adjustable-rate mortgages, ARM terms to check, and comparing Loan Estimates.

Ready to discuss a specific scenario? Explore purchase planning or refinance planning, then contact NorthStar Funding to review the written terms available for your situation. This article is general information; actual loan terms and eligibility depend on the lender’s review and applicable requirements.