What is the difference between a fixed-rate and adjustable-rate mortgage (ARM) loan?

Many ARMs will start at a lower interest rate than fixed rate mortgages. This initial rate may stay the same for months, one year, or a few years. When this introductory period is over, your interest rate will change and the amount of your payment is likely to go up.

Part of the interest rate you pay will be tied to a broader measure of interest rates, called an index. Your payment goes up when this index of interest rates increases. When interest rates decline, sometimes your payment may go down, but that is not true for all ARMs. Some ARMs set a cap on how high your interest rate can go. Some ARMs also limit how low your interest rate can go.

Know how your ARM adjusts. Before taking out an adjustable rate mortgage, find out:

• How high your interest rate and monthly payments can go with each adjustment
• How frequently your interest rate will adjust
• How soon your payment could go up
• If there is a cap on how high your interest rate could go
• If there is a limit on how low your interest rate could go
• If you will still be able to afford the loan if the rate and payment go up to the maximums allowed under the loan contract

Tip: Don’t assume you’ll be able to sell your home or refinance your loan before the rate changes. The value of your property could decline or your financial condition could change. If you can’t afford the higher payments on today’s income, you may want to consider another loan.

If you’re shopping for a mortgage, visit Buying a house, our set of tools and resources for homebuyers. If you already have a mortgage, use this checklist  to see what steps you can take to make the most out of your mortgage.