A simulation approach to the choice between fixed and adjustable rate mortgages

This study uses a simulation approach to model the choice between a fixed rate mortgage (FRM) and an adjustable rate mortgage (ARM). Our simulations help assess the risks and benefits of choosing an ARM rather than a FRM. We represent the risk of the ARM with distributions of present value cost differentials for a variety of mortgage life periods. We provide insight on the financial planning aspect by modeling the impact of mortgage rate changes on the size of payments for ARMs. The simulations yield non-intuitive results that may lead to better decision making by borrowers.