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Mortgage Basics: Fixed-Rate, ARMs, and Points

5 min read

How a Mortgage Works

A mortgage is a loan secured by real estate. You borrow a lump sum to buy a home and repay it—with interest—over a set term, typically 15 or 30 years. The property serves as collateral: if you stop paying, the lender can foreclose.

Your monthly payment has four components, often remembered as PITI:

  • Principal — the amount you borrowed, paid down gradually
  • Interest — the lender's fee, calculated on the remaining balance
  • Taxes — property taxes, held in escrow by the lender
  • Insurance — homeowners insurance (and PMI if your down payment is under 20%)

Early in the loan, most of your payment goes to interest. Over time, the principal share grows. This is called amortization, and it's why selling or refinancing within the first few years is often a losing proposition—you've barely touched the principal.

Fixed-Rate Mortgages

A fixed-rate mortgage locks your interest rate for the entire term. Your monthly principal-and-interest payment never changes.

15-year fixed. Higher monthly payments, but you pay far less total interest and build equity faster. Rates are typically 0.5%–0.75% lower than 30-year loans. Best for buyers who can comfortably afford the higher payment and want to be mortgage-free sooner.

30-year fixed. The standard. Lower monthly payments and more breathing room, but you pay significantly more interest over the life of the loan. On a $400,000 loan at 7%, the 30-year option costs roughly $200,000 more in total interest than the 15-year.

When fixed-rate wins: Rates are low, you plan to stay in the home 7+ years, or you value payment predictability above all else.

Adjustable-Rate Mortgages (ARMs)

An ARM starts with a lower fixed rate for an initial period, then adjusts periodically based on a market index. A 5/1 ARM means the rate is fixed for 5 years and adjusts once per year afterward. A 7/6 ARM is fixed for 7 years and adjusts every 6 months.

ARMs have caps: an initial adjustment cap, a periodic cap, and a lifetime cap (often 5% above the start rate). So if your 5/1 ARM starts at 5%, the rate can never exceed 10%, no matter how high rates climb.

When an ARM wins: You expect to move or refinance before the fixed period ends. If you're in a starter home or relocating in 5 years, you'll never experience the adjustment. ARMs also make sense when fixed rates are unusually high relative to ARMs—a temporary savings window.

The risk: If you stay past the fixed period and rates have risen, your payment can jump substantially. In 2022–2023, 5/1 ARM borrowers coming off their fixed period saw rates reset from ~3% to ~7%.

Mortgage Points: Prepaying Interest

Points are an upfront fee you pay at closing to buy down your interest rate. One point costs 1% of the loan amount and typically reduces your rate by 0.25%. On a $400,000 loan, one point costs $4,000.

Whether points are worth it depends entirely on your break-even period. Divide the upfront cost by the monthly savings. If one point costs $4,000 and saves you $80/month, the break-even is 50 months (just over 4 years). Stay longer than that, and you come out ahead. Sell or refinance sooner, and you lose money.

Points generally pay off when:

  • You're confident you'll stay in the home 7+ years
  • You have extra cash at closing and value lower monthly payments
  • Rates are high and you expect them to stay there

Points generally don't pay off when:

  • You might move or refinance within 3–5 years
  • You need that cash for an emergency fund or renovations
  • You expect rates to drop, making a no-cost refinance attractive soon

The Rate Isn't Everything

Closing costs, lender fees, and the loan structure matter just as much as the rate. Get Loan Estimates from at least three lenders and compare them line by line. A 6.75% rate with $2,000 in lender fees is better than a 6.5% rate with $8,000 in fees if you won't stay long enough to recoup the rate difference.

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