Fixed-rate mortgages and adjustable-rate mortgages (ARMs) are the two primary mortgage types. While the marketplace offers numerous varieties within these two categories, the first step when shopping for a mortgage is determining which of the two main loan types best suits your needs.

Mortgage fixed loan rates are for those who want to lock in their rate for the duration of the mortgage. Mortgage loan variable rates, on the other hand, fluctuate along with market changes.

Fixed rates provide stability and protection against dramatic fluctuations in interest rates over time. Variable Loan Rates can offer a reduced monthly payment, but at a greater risk to potentially higher interest payments over time.

The two types of mortgage loans available are fixed mortgage loans and variable mortgages. Fixed mortgage loans require that you pay the same amount every month until your loan is paid off. Variable mortgages allow you to pay more or less each month depending on how much interest rates rise or fall during that period of time.

Fixed-rate mortgages are good for people who want a fixed number of monthly payments and fixed monthly costs. Variable-rate mortgages have lower interest rates, but also have the possibility that the interest rate could change at any time.

ARM Terminology

ARMs are significantly more complicated than fixed-rate loans, so exploring the pros and cons requires an understanding of some basic terminology. Here are some concepts borrowers need to know before selecting an ARM:

  1. Adjustment Frequency: This refers to the amount of time between interest-rate adjustments (e.g. monthly, yearly, etc.).

  2. Adjustment Indexes: Interest-rate adjustments are tied to a benchmark. Sometimes this is the interest rate on a type of asset, such as certificates of deposit or Treasury bills. It could also be a specific index, such as the Secured Overnight Financing Rate (SOFR), the Cost of Funds Index or the London Interbank Offered Rate (LIBOR).

  3. Margin: When you sign your loan, you agree to pay a rate that is a certain percentage higher than the adjustment index. For example, your adjustable rate may be the rate of the one-year T-bill plus 2%. That extra 2% is called the margin.

  4. Caps: This refers to the limit on the amount the interest rate can increase each adjustment period. Some ARMs also offer caps on the total monthly payment. These loans, also known as negative amortization loans, keep payments low; however, these payments may cover only a portion of the interest due. Unpaid interest becomes part of the principal. After years of paying the mortgage, your principal owed may be greater than the amount you initially borrowed.

  5. Ceiling: This is the highest that the adjustable interest rate is permitted to reach during the life of the loan.