The 30-year fixed-rate mortgage dominates the American landscape, but the adjustable-rate mortgage gains some steam when rates are rising.
Because the initial ARM rate is usually lower than fixed-rate loans’, buyers who expect to sell within a few years are sometimes attracted to the low rates and payments.
Find out whether a fixed-rate or adjustable-rate mortgage works better for your particular situation.
Adjustable-Rate Mortgage Loans
In a nutshell: lower initial rate, more risk.
In most cases, an ARM rate will be fixed for three, five, seven, or 10 years and then periodically adjust.
ARMs are labeled with numbers that delineate a) the length of the introductory fixed phase and b) the frequency of rate adjustments afterward. The 5/1 ARM, for example, has a low five-year introductory rate that can then change every year for the remainder of the loan.
If you see a 7/6 or 10/6 ARM, that means the rate can adjust every six months after the introductory period.
Pros of Adjustable-Rate Mortgage Loans
A five- or seven-year ARM tends to have an introductory rate that’s lower than that of a 30-year fixed-rate conventional or FHA loan. A three-year ARM rate may be much lower.
So during periods of rising mortgage rates, ARMs offer a great option for borrowers to save money before the initial rate adjustment.
That includes first-time homebuyers who are looking for lower initial rates and monthly payments and who understand that their rate will likely rise if they keep the loan.
Also, higher conforming loan limits in 2022 made it possible for lenders to qualify more borrowers for ARMs that could be backed by Fannie Mae, Freddie Mac, and Ginnie Mae.
ARMs have caps on how much the rate can increase or decrease. There is usually an initial cap, a periodic adjustment cap, and a lifetime cap. More and more of the loans have rates tied to a new index, the Secured Overnight Financing Rate (SOFR). For those, the rate may go up or down a maximum of one percentage point every six months (which is why you see a 7/6 and so on) after an initial adjustment, which could be two or five percentage points, with a 5% lifetime cap.
Cons of Adjustable-Rate Mortgage Loans
ARMs provide less stability than fixed-rate mortgages. After the initial fixed-rate period, there’s no certainty about how much monthly payment amounts will go up or down.
Most ARMs are fully amortizing, but if you choose an interest-only loan, you won’t be paying down any principal for years.
One set of ARM devotees plans to refinance the loan before the initial rate adjustment — to a fixed-rate loan or to another adjustable-rate mortgage — betting that rates will be lower then. But that’s a risk.
Fixed-Rate Mortgage Loans
In a nutshell: long-term predictability.
A fixed-rate mortgage has an interest rate that stays the same for the life of the loan, regardless of changes in the broader economy.
Pros of Fixed-Rate Mortgage Loans
Fixed-rate mortgages offer greater stability and predictability over the long term compared with adjustable-rate loans.
The National Association of Realtors® puts the average homeowner tenure at 10 years. Redfin found that the typical homeowner had spent 13.2 years in their home in 2021. Older homeowners may stay longer. So if you’re not going to get a move on within a few years, it may be comforting to lock in. You can refinance later if rates decrease.
Cons of Fixed-Rate Mortgage Loans
The 30-year fixed-rate home loan has a higher average interest rate than most ARM introductory rates.
Small differences in interest rates can add up. Use a mortgage calculator to see for yourself.
Then again, lifetime rate caps on most ARMs are five percentage points above the introductory rate.
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Lay the Groundwork for a Mortgage
Do you know how much of a mortgage you can afford?
You can get an idea by pre-qualifying with lenders and using a home affordability calculator.
Then there’s pre-approval for a mortgage, which requires a credit check and provides a specific amount that you can tentatively borrow.
Which lender will offer you the best loan options and the most competitive rates?
Think About How Long You May Keep the House
How long might you live in the home? If short term, an ARM might make sense.
If the rates you see are close to those of a fixed-rate mortgage, you might go with predictability.
Consider How Quickly You May Want to Pay Off Your Mortgage
If you go the traditional route, should you choose a 15-year or 30-year mortgage?
Generally the shorter the mortgage term, the lower the rate. Some people who can afford to make a high monthly payment take out 10-year loans.
Even if you initially take out a mortgage for a certain number of years, you have the option to pay off the mortgage early.
Understand How Your Adjustable Rate Would Work
If you’re seriously considering an adjustable-rate mortgage, you’ll want to understand the rate caps and adjustments.
If your rate reached the maximum, would you still be able to afford the payments?
It doesn’t hurt to get loan estimates for both fixed-rate and adjustable-rate mortgages when shopping for a mortgage. After learning the loan details, you may decide that an ARM is right for you. If you aren’t comfortable with the terms, you might opt for a fixed rate.
The Takeaway
If you’re looking for a mortgage, you’ll want to think about how long you might stay in the home and whether you’ll want to refinance in the coming years. Weigh the pros and cons of an adjustable-rate loan and a fixed-rate loan to decide what might be best for your situation.
If a fixed-rate mortgage seems the way to go, check out the deals and term lengths SoFi offers. And know that the rates are competitive.
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