fixed-rate vs. adjustable-rate mortgages. which is best for you?
Before deciding on the neighborhood and school district, before choosing between the brick ranch or the historic Victorian, and maybe even before selecting a mortgage lender, the biggest decision a homebuyer is likely to make is which kind of mortgage to choose.
After all, it'll be with you for up to 30 years.
There are two primary options:
A fixed-rate mortgage: This home loan charges the same interest rate over its full life, so the payment amount never changes. Fixed-rate loans are typically offered in 30-, 20-, or 15-year plans, with shorter-term plans offering lower interest rates.1
An adjustable-rate mortgage (ARM): Also called a variable-rate mortgage, this home loan's interest rate is tied to the national interest rate, so it can change over time, but it will have the same interest rate for between 3, 5, 7, and 10 years. That said, the loan typically kicks off at a rate that is lower than the market rate. Then, after the introductory period, say three or seven years, the rate could go up (or down).2
So what's the best fit for your needs?
Just like the benefits of a ranch home may vary from one homeowner to another, the pros and cons of fixed-rate vs. ARM loans will differ depending on the borrower's short- and long-term goals. Here's a simple breakdown.
Fixed-rate loans – pros and con:
Pro: Borrowers are unaffected by sudden changes in interest rates.
Pro: Because interest does not change for the life of the loan, the payments never change. This makes them easier to budget.
Con: If interest rates are high at the time of borrowing, it could be more difficult to qualify because it will make payments more costly.
ARM loans – pros and con:
Pro: They’re less expensive in the lower-interest introductory period, making it easier for the borrower to qualify for a larger loan.
Pro: If interest rates drop, the borrower could benefit because total payments could decline.
Pro: Lower interest rates mean you can afford more home, maybe even your dream home.
Con: Payment amounts can change frequently, making it more difficult to budget.3
Still unsure? Timing, circumstances can help you decide
Rising interest rates are causing some homebuyers to consider ARM loans. This is because fixed-rate mortgages lock in at the current interest rate, so they are more expensive right now.4 Homebuyers thinking about ARMs are likely expecting interest rates to dip, meaning lower payments down the road.
Circumstances also should play a role in your decision. Consider career and family plans that could change what you can afford, as well as your savings to cover unexpected events, from job loss to illness to a new roof on a Victorian home. Here are some guidelines:
When to consider a fixed-rate mortgage. Long-term borrowers tend to seek out fixed-rate mortgages so they can lock in to stable payments for the life of the loan. In 2021, when the average rate on a 30-year loan was barely 3%,5 mortgage debt rose by nearly 7.6%.6 Borrowers who do not expect significant changes in their income and expenses are good candidates.
When to consider an ARM. Borrowers who plan to stay in the home for fewer than 10 years may be financially better off with an ARM. This is because they will sell their house before the introductory period of their loan expires and higher rates take over. Also good candidates: Those who will have the money to pay off the entire loan before higher rates kick in.
Keep your best interest in mind
Regardless of the market rate, borrowers should know that other factors can influence the interest rate applied to a home loan. These include credit scores (the higher your score, the better your rate), the length and size of the loan, and even the rate of inflation.7
A good mortgage loan officer can walk you through these factors and help you determine whether they will alter your rate. This, too, can help you decide which kind of mortgage is best for you and your financial health. Together, we can run the numbers to determine the worst- and best-case scenarios.
But whether to buy the ranch or Victorian? That choice is all yours.
First Financial's mortgage loan officers are happy to answer any of your questions. You can set up an appointment easily, right here. Curious to know how much you can afford to pay first? Our handy online mortgage calculator can figure out your monthly fixed-rate payment depending on down payment and loan length.