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Option ARM vs. Fixed Rate Mortgage

A fixed rate mortgage has the same payment for the entire term of the loan. The Option ARM uses a low initial rate to calculate your initial minimum monthly payment. Although the interest rate will increase after 1 to 3 months, your low payment will remain fixed for the entire year. This can produce a much lower monthly payment than a traditional fixed rate mortgage, or even an adjustable rate mortgage (ARM).

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Definitions

Fixed Rate Mortgage
A fixed rate mortgage has the same interest rate and monthly payment throughout the term of the mortgage. The payment is calculated to payoff the mortgage balance at the end of the term. The most common terms are 15 years and 30 years.

Option ARM Mortgage
This is a special mortgage program designed to give you a very low payment. This mortgage can result in your principal balance increasing when the monthly payment doesn't cover all of the accrued interest.

Fully indexed rate (FIR)
This is the interest rate used to accrue interest on the Option ARM after the initial fixed period has ended.

Maximum annual increase
This is the maximum amount the Option ARM's monthly payment can increase each year through year five, regardless of the Fully Indexed Rate (FIR).

Fully Amortizing ARM
This is the most common type of ARM. The monthly payment is calculated to payoff the entire mortgage balance at the end of the term. The term is typically 30 years. After any fixed interest rate period has passed, the interest rate and payment adjusts annually. A Fully Amortizing ARM will also have a maximum rate that it will not exceed. This calculator uses a maximum interest rate of 12%. Below is a list of the most common types of Fully Amortizing ARMs.

Common Adjustable Rate Mortgages
ARM TypeMonths Fixed
10/1 ARMFixed for 120 months, adjusts annually for the remaining term of the loan.
7/1 ARMFixed for 84 months, adjusts annually for the remaining term of the loan.
5/1 ARMFixed for 60 months, adjusts annually for the remaining term of the loan.
3/1 ARMFixed for 36 months, adjusts annually for the remaining term of the loan.
1 year ARMFixed for 12 months, adjusts annually for the remaining term of the loan.
Interest Only ARM
An Interest Only ARM only requires monthly interest payments. Since you are not paying any principal, as you are with the other two types of mortgages described above, this can lower your monthly payment. However, since your mortgage's principal balance is not decreased, you will either have a balloon payment at the end of the mortgage's term or at some point the mortgage will convert to a Fully Amortizing ARM. Like a Fully Amortizing ARM, an Interest Only ARM will often have a period where the interest rate is fixed, and then it is adjusted annually. An Interest Only ARM will also have a maximum interest rate that it will not exceed. This calculator uses a maximum interest rate of 12%.

Mortgage amount
Expected balance for your mortgage.

Term in years
The number of years over which you will repay this mortgage. The most common mortgage terms are 15 years and 30 years.

Expected rate change
The annual adjustment you expect in your ARM. The range for this calculator is minus 3% to plus 3%. Use a negative value if you believe interest rates will decrease, a positive value if you believe they will increase.

Interest rate
Annual interest rate for each mortgage type. Typically an ARM will have a lower interest rate than a fixed rate mortgage. The rate of an Interest Only ARM will vary by lender.

Months rate fixed
This is the number of months the rate is fixed for an ARM. During this period the interest rate and the monthly payment will remain fixed. The rate will then adjust annually by the expected rate change.

Interest rate cap
This is the maximum interest rate for this mortgage. The mortgage's interest rate will never exceed the interest rate cap.

Information and interactive calculators are made available to you as self-help tools for your personal independent use and are not intended to provide investment advice. We can not and do not guarantee their applicability or accuracy in regards to your individual circumstances. All examples are hypothetical and are for illustrative purposes. We encourage you to seek personalized advice from qualified professionals regarding all personal finance issues.