Buying a house is one of life’s most exciting landmarks—not to mention one of the biggest purchases. With the average U.S. home price sitting at nearly $260,000, that usually means acquiring a fixed-rate or adjustable-rate mortgage, whose definitions are inherent in the names.
Welcome to the wide (and slightly wacky) world of mortgages. Whether a consumer is considering a fixed or adjustable interest rate is a big factor when shopping for lenders and the home loans each offers.
Read on to learn about the differences among mortgages.
Fixed Rated Mortgages Defined
A fixed-rate mortgage is, as its name suggests, a mortgage loan whose interest rate is fixed across the lifetime of the loan. The rate is stated at the time the documents are signed and does not change at any point throughout the loan term (provided that all payments are made in full and on time).
This is in contrast with an adjustable-rate mortgage, whose interest rate can move up or down according to the market. With an ARM, the interest rate is calculated according to the index and margin—the index is a benchmark interest rate based on market conditions at large, and the margin is a number set by the lender when the loan is applied for.
Long story short: A fixed-rate mortgage offers you a predictable interest rate and monthly payment, whereas an adjustable-rate mortgage can shift over the course of the loan term according to external factors.
(It is, however, important to understand that your total monthly housing bill can still change, even with a fixed-rate mortgage, if, for example, your property taxes or homeowners insurance rates change or if you miss several payments.)
Pros and Cons of Fixed-Rate Mortgages
Fixed-rate mortgages are more common among homebuyers because of the predictability they offer. Still, there are both drawbacks and benefits to pursuing this kind of home loan.
Benefits of Fixed-Rate Mortgages
Because homebuyers who take out fixed-rate mortgages will know their rates at the time they sign on the dotted line, these loans provide long-term predictability and stability—which can help people who need to fit their housing expenses into a tight budget.
Fixed-interest mortgages, and other types of fixed-rate loans, shield borrowers from potentially high interest rates if the market fluctuates in such a way that the index significantly rises.
Drawbacks of Fixed-Rate Mortgages
Although fixed-rate mortgages are more predictable over time, they tend to have higher interest rates than ARMs—at least at first. Sometimes an ARM might have a lower interest rate but only for a relatively brief introductory period, after which the rate will be adjusted.
If the index rate falls in the future, homebuyers might end up paying more in interest than they would have with an ARM.
Because the principal balance is generally chipped away at more slowly with a fixed-interest rate mortgage than with an ARM, it can take longer for borrowers to build equity in their home.
Because lenders risk losing money on fixed-interest mortgages if index interest rates go up, these loans can be harder to qualify for than their adjustable-rate counterparts.
Heads-Up on 5-Year ‘Fixed-Rate’ Mortgages
While fixed-rate mortgages generally exist in opposition to adjustable-rate mortgages, some lenders sell what’s called a fixed-rate mortgage—but which is actually an ARM in costume.
Some so-called fixed-rate mortgages with a term of only five years turn into ARMs afterward, so if a true fixed-rate mortgage is what you want, be sure to double-check with the lender that the rate will remain fixed for the entire lifetime of the loan.
When Is a Fixed-Rate Mortgage the Right Choice?
Fixed-rate mortgages offer long-term predictability, which can be a must for those who need budget stability.
Furthermore, fixed interest rates can be beneficial for those who plan to stay in their home for a longer period of time—say, at least seven to 10 years.
That way, homebuyers are less likely to miss out on building equity, as they might if they sold the house after making higher interest payments for a shorter period of time.
Finally, if homebuyers suspect that interest rates are about to rise, a fixed-interest loan can be a good way to protect themselves from those increasing rates over time.
That said, there are some instances in which an ARM may be a better choice. If a homebuyer is planning to sell in a short amount of time, for example, the low introductory interest rate on an adjustable-interest loan could save them money.
Distinctions in Types of Mortgages
Now that we’ve covered fixed-interest mortgages, let’s take a brief look at the other types of mortgages buyers may encounter when they’re shopping for a home loan.
Nitty-Gritty of ARMs
While we’ve referred to ARMs throughout this post, there are other factors to understand about these types of loans when making your decision.
Some ARMs set a cap to limit how high your interest rate can rise, no matter how high the index may go—though this isn’t always the case. Conversely, some ARMs include an interest rate limit on the low end as well, meaning your rates can never go below a certain amount.
An ARM may be easier to qualify for than a fixed-interest mortgage. One reason could be an applicant’s debt-to-income ratio. Someone with a ratio on the high side may be approved based on the lower initial payments of an ARM.
ARMs may also help buyers take advantage of falling index rates without refinancing, as they would have to if they’d taken out a fixed-interest loan.
Conventional Loans vs. Government-Insured Loans
Another important distinction in mortgage types is whether or not the loan is backed by the government.
Conventional loans—those offered by private banks and lenders—are most common, and do not include any kind of government insurance. Government-insured loans, such as Federal Housing Authority or VA loans, are subsidized by the government and may carry more flexible terms and achievable eligibility requirements.
For example, when pursuing a conventional loan from a private lender, the minimum down payment is typically around 5% (and may be higher).
But with FHA loans, applicants may qualify for a 3.5% down payment even with a credit score of 580. (That said, mortgage insurance may be required in both cases, which can significantly increase overall monthly housing expenses.)
Conforming vs. Non-Conforming Loans
Mortgages can also be considered “conforming” or “nonconforming,” depending on whether or not they meet the guidelines established by the Federal Housing Finance Agency (commonly known as Fannie Mae and Freddie Mac). In 2020, the conforming loan limit for one-unit properties was $510,400, or $765,600 in areas deemed “high cost.”
Of course, homes costlier than these limits exist, and it is possible to take out mortgage to buy one. Those loans are considered “nonconforming” and are also sometimes called “jumbo loans.”
Because the loans are so large, eligibility requirements tend to be more stringent, with borrowers needing a down payment of at least 10% and a solid credit score.
A Lender Worth a Look
When you’re in the market for a home, shopping for the right loan is almost as important as shopping for the house itself.
Although there are many mortgage lenders to choose from, including government-insured options, SoFi® offers competitive rates on conventional, fixed-rate mortgages with terms ranging from 10 to 30 years.
SoFi® offers loans with a down payment as low as 10%, and a mortgage loan officer can guide you through what can be a complicated process. Members can rest assured that questions they have will be answered by professionals who are just a phone call away.
Along with offering initial mortgages, SoFi® also helps homeowners who are looking to refinance in order to save money on interest over time or obtain lower monthly payments.
There are no hidden fees.
SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC), and by SoFi Lending Corp. NMLS #1121636 , a lender licensed by the Department of Financial Protection and Innovation under the California Financing Law (License # 6054612) and by other states. For additional product-specific legal and licensing information, see SoFi.com/legal.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.