Fault Domains – refers to rack of servers with subsystems like network, power, cooling etc. VMs in the same availability set means Azure will provision them in 2 different racks. The maximum value of fault domain is 2.
Update Domain – refers a logical unit of a deployment. Whenever any update needs to be applied at the host level, the VMs in same update domain would be restarted in the order to avoid impact to services and applications.