A fixed-rate mortgage is a home loan in which the interest rate will remain the same through the life of the loan for the original borrower. The most common fixed-rate mortgage terms are 15 or 30 years, but loans may also be available for 10, 20 and 25 years.
Fixed-rate mortgages are characterized by their interest rate (including compounding frequency, amount of loan, and term of the mortgage) and are known for their ease of comprehension among borrowers. Unlike adjustable-rate mortgages, fixed-rate mortgages are not tied to an index. Instead, the interest rate is set to an advertised rate, usually in increments of 1/4 or 1/8 percent.
Fixed-rate mortgages are usually more expensive than adjustable-rate mortgages. Long-term fixed-rate loans will tend to be at a higher interest rate than short-term loans because of increased risk.
Adjustable-Rate Mortgage (ARM)
An adjustable-rate mortgage (ARM) is a home loan in which the interest rate changes periodically based on a standard financial index. ARMs generally permit borrowers to lower their initial payments if they are willing to assume the risk of interest rate changes. They transfer part of the interest rate risk from the lender to the borrower, who benefits if the interest rate falls but loses if the interest rate increases. To limit this risk, most ARMs have caps on how much an interest rate may increase over the initial term and life of the loan.
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