Generally, there are two mortgage types: a fixed-rate mortgage with an interest rate that remains the same for the life of the loan, or an adjustable-rate mortgage (ARM) with a rate that adjusts up or down, depending upon economic trends.

Fixed Rate Mortgages

The advantages of a fixed-rate mortgage – particularly if you lock
in at a low rate – are that they protect you against the risk of rising interest rates, and their stability can also make it easier for you to plan and budget your short and long-term expenses. Their down side is that they generally have higher rates than ARMs at any given time, and by locking in you run the risk of being trapped at a relatively high rate if interest rates fall.

In this connection, another main consideration when getting a fixed- rate mortgage is the term. Shorter term mortgages like a 15-year have lower rates than a 30-year. The shorter term and lower rate mean that you’ll pay both less principal and interest over the life of the loan, although your monthly payments will generally be higher.

Adjustable Rate Mortgages

On the other hand, an adjustable-rate mortgage’s (ARM) rate is commonly based on the U.S. Treasury Index for a one-year treasury bill, although it may also be geared to other indexes. Generally, lenders add 2-4% to the index rate to get their ARM rate. Initially, the rate is lower than the fixed rate by a quarter point to two points or more. This rate will periodically adjust within set limits or “caps” that are specified by the terms of the loan.