Fixed-rate mortgages and adjustable-rate mortgages (ARMs) are the two primary mortgage types. A fixed-rate mortgage charges a set rate of interest that does not change throughout the life of the loan. (If your payment includes escrow amounts for taxes and insurance, that portion could still change.) A fixed-rate mortgage is amortized over 30 years, so you have 360 identical principal and interest payments.
ARMs are typically more complicated than fixed-rate mortgages and the interest rate for ARMs is variable. An ARM interest rate changes after the fixed period expires. The low rate will stay the same for a certain period, often for 7 or 10 years. After the fixed-rate period ends, your interest rate will adjust up or down based on an index.
According to the Origination Insight Report from Ellie Mae, just 2.4 percent of new mortgages were ARMs in November 2020. However, according to the same report, in December 2018, 9.2 percent of all new mortgage loans had an adjustable rate. Assuming rates continue to rise, will ARMs make another comeback? Let’s take a closer look at both options to help you decide whether a fixed-rate mortgage or an ARM is currently the better option for you.
Fixed Rate Mortgage Benefits
Not only will the fixed rate you secure today be the same rate 10, 20, and 30 years from now, but the 30-year fixed-rate mortgage is also attractive because you can purchase a home with as little as 5% down. While mortgage insurance (PMI) will be required on down payments of less than 20%, the lower down payment can shorten the homeownership timeline for some buyers. You can learn more about mortgage insurance here.
Additionally, many borrowers eventually refinance to another fixed rate mortgage to eliminate mortgage insurance if property values increase. It’s worth noting that qualifying for a loan can be more difficult when interest rates are high because the payments are less affordable.
Adjustable-Rate Mortgage Benefits
Interest rates for ARMs are generally lower than interest rates on fixed-rate loans, at least for a few years. Another benefit of an ARM is that if you have a high debt-to-income ratio (DTI), you may have an easier time qualifying than with a fixed-rate mortgage. Learn more about DTI here.
Today’s ARMs are typically hybrids, which are 30-year loans with a fixed interest rate for a period of five, seven or ten years, followed by an annually adjusted mortgage rate for the rest of the loan term. At the beginning of your loan, you’ll get a low, introductory interest rate that’s set generally below the rate on a comparable fixed-rate loan.
Additionally, ARMs have rate caps that limit the amount that your interest rate can rise or drop in a single period and over the lifetime of your loan. Your loan might not increase or decrease exactly along with the market if it hits its cap. Your mortgage consultant can provide additional information about aspects such as “initial caps” and “lifetime caps.”
Which Mortgage is Right for Me?
ARMs and fixed-rate loans both offer the same term lengths including the common 30-year term. In some scenarios, an ARM may make more sense, particularly if you don’t plan on staying in your home longer than five years. Often by the end of the 5-year fixed period, borrowers can make a much bigger dent in their balance than if they went with a 30-year fixed mortgage. This is because adjustable-rate mortgages carry lower interest rates during the fixed period of the loan, which can make big difference in your payment.
However, a fixed-rate mortgage is the most popular type of financing because it’s the most predictable type of loan. This means the mortgage payment for principal and interest will never change, providing you stability.
Want some help with deciding which option may be best for you?
You can get an idea of what a 30-year fixed, or an ARMS mortgage may look like for you with our mortgage calculators. Need some help right away? Call 888-673-5521 to speak with one of our mortgage consultants about a mortgage option that works for you.
