30 Year Fixed Rate Mortgage vs ARM Mortgages: What’s the Difference?

Posted on October 12, 2022 in Mortgage FAQ's

Are you ready to put down roots and purchase a home? If so, a mortgage can help you afford your new property, allowing you to pay for it over time. There are many aspects to consider when researching available mortgage options. One question you might be asking yourself is what is the difference between a 30 Year Fixed Rate Mortgage vs ARM Mortgages. The lower interest rates of an ARM might pique your interest at first, but is it the right choice? Today, we’re comparing these two common types of mortgages to help you decide which one is best for you. 

What Is a Fixed Rate Mortgage?

With a fixed-rate mortgage, homebuyers pay the same interest rate for the entire life of the loan. This means that you can expect the same monthly payment, which includes both your principal and interest. 

While this offers a degree of stability, keep in mind that you could see a change in your mortgage payments over time, but only under two conditions:

  • Your property taxes change 
  • Your homeowner’s insurance changes

These costs are typically included in your loan payments in escrow, so if they fluctuate, you’ll notice the difference in your invoice. However, your basic principal and interest will remain the same. 

For many homebuyers, a Fixed Rate Mortgage is ideal because it’s predictable. You can plan around it, and you know what to expect each month. For this reason, 30-year Fixed Rate Mortgages are considered the most common type of mortgage today. 

Yet, there’s a price to pay for such security. Lenders usually charge a higher interest rate for Fixed Rate Mortgages than they do for Adjustable Rate Mortgages.

Pros and Cons of a Fixed Rate Mortgage

Love the predictability and constancy a Fixed Rate Mortgage can bring? This could be the right choice for you, but it’s important to understand both sides. Let’s take a look at the pros and cons of choosing this option. 

Pros of a Fixed Rate Mortgage

Why should you choose a Fixed Rate Mortgage? Here are some of the top benefits you can expect with this type of loan.

Financial Security 

First, there’s the obvious advantage: Fixed-rate mortgages provide a sense of financial security. Once you lock in a rate, you can rest assured it won’t change, no matter what happens in the economy. Typical term lengths for Fixed Rate Mortgages are; 10, 15, 20, and 30 Year Mortgages.

Easier to Budget

The regularity of a Fixed Rate Mortgage makes basic household budgeting much easier. You know that your housing payment won’t change, so that’s one expense you can plan around.

Whether you’re planning your monthly grocery runs or saving for a big trip, it helps to know exactly how much is going toward your mortgage each month. 

Easier to Understand

These loans are also relatively straightforward and easy to understand. Especially if you’re a first-time homebuyer, the process can be complicated and full of complex paperwork and jargon. 

A Fixed Rate Mortgage takes out much of the guesswork. You don’t have to navigate all of the nuances that can accompany an Adjustable Rate Mortgage, which can make this a more appealing route. 

Cons of a Fixed Rate Mortgage

While it can be beneficial for many homeowners, an FRM isn’t for everyone. Here are a few potential drawbacks to consider. 

Harder to Take Advantage of Low Rates

When interest rates are on the rise, homeowners with an FRM are usually glad they already locked in their lower rate. Yet, it can be discouraging to see rates fall below yours and know that you can’t take advantage of them as easily. 

If you want to capitalize on lower rates, you’ll have to go through an extensive refinance process, which can take a while to complete. There are also borrowing fees and costs associated with taking that step. 

Difficult to Customize

Do you have a circumstance that warrants a customized mortgage tailored specifically to your needs? If so, you might not be able to find that degree of flexibility with an FRM. 

Most of these loans are virtually identical from one lender to the next, and there’s little room for personalization. 

Could Cost More

Unless you refinance, you could wind up spending more with a 30-year FRM than an ARM. This may happen if you secure the loan at a higher interest rate and those rates eventually lower. 

In that case, you’ll pay more in interest over the life of the loan than someone else with the same terms. Of course you always have the option of refinancing your loan at a later date to take advantage of the lower rate.

What Is an Adjustable Rate Mortgage (ARM)?

As its name implies, an adjustable rate mortgage (ARM) is a type of home loan in which the interest rate can change from time to time. This timing is spelled out in your loan documents up front, so there shouldn’t be any surprises for when it would start adjusting, if at all.

Instead of seeing the same numbers each time you open your monthly invoice, you can expect your payments to go up or down throughout the life of the loan. While this type of uncertainty might seem daunting, the upside is that most lenders charge a lower initial interest rate for an ARM than an Fixed Rate Mortgage.

During that initial period, the interest rate will be fixed and will not fluctuate. Then, once that period ends, the interest rate will become tied to a certain type of index. The performance of that index determines your monthly payment. 

There are many different types of indices, and they’re all determined by external market forces. When you work with your lender to set up an ARM, they’ll provide you with detailed loan paperwork that identifies which index each ARM mortgage follows.

Interest rates for these indices can be difficult to forecast, and they’re often influenced by outside events. For instance, ARM interest rates have been historically low since the onset of the COVID-19 pandemic 

Interest rates are unpredictable, and have reached historic lows during the COVID-19 pandemic. Now, it appears, they’re back on the upswing

Types of ARMs

There are different kinds of Adjustable Rate Mortgages. They are labeled by the duration of their initial “fixed-rate” period. 

For instance, a 5/1 ARM mortgage has an introductory rate that lasts for five years. That explains the “5” in the title. The “1” refers to how often the interest rate can change per year. 

That change will be based on the index listed in your loan agreement. It will also account for a margin that your lender will set. In the case of a 5/1 ARM, it can change one time per year.

While 5/1 ARMs are the most common, lenders can also offer other options. Some of the most popular ones include: 

  • 3/1 ARMs
  • 7/1 ARMs
  • 10/1 ARMs 

A 7/1 ARM mortgage is in the middle of the range, with a seven-year introductory period and only one interest fluctuation per year. It’s another common type of ARM. 

Pros and Cons of an Adjustable Rate Mortgage

An Adjustable Rate Mortgage can be advantageous to many prospective homebuyers, but the flexible rates aren’t ideal for every circumstance. Let’s take a look at the pros and cons. 

Pros of an ARM

There are many features that make an ARM beneficial. Here are some of the top ones. 

Low Early Rates

An ARM will have lower rates and payments at the beginning of the loan term. This could help you qualify for a larger mortgage and a more expensive home than you could be eligible for with a 30-year fixed mortgage.

Your lender will take the lower interest rate into account when accessing your application. If you have your eye on a larger home, this could be a viable route. However, keep in mind that once the initial, introductory period is over, you’ll be responsible for shouldering that monthly bill.

Make sure you can afford to pay more than those low, early rates before agreeing to an ARM. 

Opportunity to Save

When you’re spending less money on your house payments each month, you can put those excess funds to good use.

Many homeowners with an ARM choose to keep and invest those savings, opting for high-yield investments that garner good returns. 

Not As Affected by Rate Fluctuations

If you have a Fixed Rate Mortgage, it can be disheartening to watch the interest rates fall, knowing that yours is relatively unchangeable.

With an ARM, you’re less affected by those external conditions. When rates are lower, you can take advantage of that dip without refinancing. Instead, you’ll simply notice that your bill is lower during that period, and you get to reap the reward!

Good for Short-Term 

Do you plan to live in your new home forever? Or, are you going into this transaction aware that you’ll only be there for a few years? 

If you don’t plan to stay in your new residence for the long-term, then an ARM offers you the opportunity to take advantage of an early low rate, then sell before the initial period is up. 

Cons of an ARM

While an ARM can help your situation and your pocketbook, it also has its drawbacks. Let’s take a look at a few reasons you might want to give this option a closer look before agreeing to it. 

Potential to Rise

Yes, it’s great to have an ARM when rates are low. However, keep in mind that rates also tend to increase over time.

When this happens, it can shock your budget, especially if you’ve grown comfortable with those early introductory rates. That’s why it’s important to make sure you can afford your mortgage even when the market doesn’t work in your favor.

Can Be Overly Complex

Most 30-year fixed mortgages operate in the same way. They’re simple and straightforward, which makes them ideal for first-time homebuyers

Comparatively, ARMs are much more complex to navigate. Instead of working off one set of standards, lenders have much more flexibility when creating these types of mortgages. From margins and caps to adjustment indices, they can customize many different elements. 

As such, it can be easy to get confused when you’re in this process. You could even wind up agreeing to terms you don’t fully understand. Before signing on the dotted line, ask your lender to explain anything that’s unclear. 

Initial Loan Adjustment 

When your loan is initially adjusted and the intro period goes away, that first reset can come as a shock to your budget. While there are annual caps in place to control your rates from getting too high, they don’t always apply to the first loan adjustment. 

Which One Should You Choose?

Now that we’ve covered both types of mortgages in full, it’s time to think about which one will work best for you and your family. As you’ve seen, there are pros and cons to each one. It helps to answer a few simple questions before you dig into more research. Here are the most important ones to ask.

Short-Term vs. Long-Term Purchase

First, ask yourself how long you plan to be in this new home. If you’ll only be there a few years, a lower-rate ARM may be best, especially if you can secure a 5/1 or 7/1 option. 

If you move before the adjustable-rate period begins, you can take advantage of those early initial savings!

Current Interest Rates

What is the interest environment looking like lately? If rates are high, an ARM can help you save money each month. If they’re low, a Fixed Rate Mortgage might make more sense.

This allows you to lock in that low rate, so you’re protected when they rise again. 

What Is the ARM Adjustment Period?

If you’re eyeing an ARM, look to see how often the rates adjust. After the initial period, most will adjust once per year, on the anniversary of the mortgage.

However, there are some ARMs that adjust as frequently as every month. Make sure you can handle the degree of volatility that yours presents. 

What Happens If Payments Rise?

Can you still afford your monthly mortgage payment if interest rates rise significantly? When rates are low, Fixed Rate Mortgages tend to be a better deal than ARMs, regardless of how long you plan to stay in your house. That’s because ARM rates can vary a lot from year to year, according to market conditions. If you can’t afford those payments when they’re high, it’s smart not to invest when they’re low. 

Is a 30 Year Fixed Mortgage Right For You?

There are lots of different mortgages out there. A 30-year fixed mortgage and an ARM are two of the most common types.

As you navigate all of these options, make sure you understand the terms and conditions before agreeing to anything. Involve your lender or real estate professional to help clear up confusion and ensure you’re making the right decision. 

Looking to buy or build a home in the Raleigh NC area? We have the properties and floor plans you’re looking for! Take a look at our available homes today and contact us with any questions.

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