Fixed vs. adjustable-rate mortgage: What’s better in 2021?
Should you choose a fixed- or adjustable-rate loan?
When picking a mortgage product, you have two options to choose from: A fixed-rate loan or an adjustable-rate one.
With a fixed-rate mortgage, you get a set interest rate and payment for the entire loan term. Adjustable-rate mortgages, on the other hand, have rates that can change over time.
Both options have their perks and some drawbacks, too. The right one for you will depend on your homeownership plans and financial goals. Here’s how to choose.
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Fixed vs. adjustable-rate mortgage: What’s the difference?
The main difference between a fixed-rate mortgage (FRM) and an adjustable-rate mortgage (ARM) is the type of interest rate you receive.
- On a fixed-rate loan, the interest rate you start off with is the rate you’ll have for the entire time you have the loan. That means your monthly payment — at least the mortgage part of it (not your taxes, for example) — remains consistent for your full loan term
- Adjustable-rate mortgages have interest rates that are variable — meaning they fluctuate. You’ll usually have your initial interest rate for a few years (typically three, five, seven, or 10), and then the rate will change based on the index it’s tied to. Many times, your rate will increase, which also increases your monthly mortgage payment
Adjustable-rate mortgages are riskier than fixed-rate ones, but they also come with lower interest rates — at least at the beginning of the loan.
This is why it’s important to weigh the full pros and cons of both mortgage types (as well as your own financial goals) before deciding which to go with.
Pros and cons of a fixed-rate mortgage
|Fixed-rate mortgage pros||Fixed-rate mortgage cons|
|Consistent interest rate for the entire loan term||Higher rates than adjustable-rate loans (at least at the beginning)|
|Easy to budget for (monthly payments are always the same)||Higher monthly payments|
|No prepayment penalties||May be harder to qualify for|
|Good for long-term homeowners||May not be as good for short-term homeowners|
Fixed-rate mortgage benefits
Fixed-rate mortgages are by far the most common type of mortgage loan — and for good reason. For one, they’re consistent. There are no surprise hikes in payments, and they’re easy to budget and plan for.
FRMs also come with very long loan terms (often 30 years), which allows you to spread out your payment over many months and years. This can help you minimize your monthly payment and make homeownership more affordable.
Fixed-rate mortgage drawbacks
The downside of fixed-rate mortgages is that rates are higher than on adjustable-rate loans — at least for the first few years of the loan. This can mean paying more in interest and a higher monthly payment, especially if you’ll only be in the home for a few years.
Another drawback is that a fixed-rate loan can be harder to qualify for.
Since fixed mortgage rates are higher (and monthly payments, too), you’ll need to prove you can cover those bigger payments — often with a lower debt-to-income ratio, higher credit score, or more in savings and cash reserves.
Generally speaking, fixed-rate loans are better for long-term homeowners. If you expect to only be in your home a few years (say, less than 5), an adjustable-rate mortgage might be your best bet.
Why most people choose a fixed-rate loan
The vast majority of home buyers choose a fixed-rate mortgage.
For one, they like the consistency an FRM can offer. Few buyers — especially first-time home buyers — are comfortable with the risk that adjustable-rate mortgages come with. They want a steady, predictable monthly payment they can budget and plan ahead for.
Adjustable-rate mortgages are also lesser-known than fixed-rate ones. Many buyers simply don’t know about them — or at least have the full scoop on how they work — before applying for a loan.
If you’re in this boat, make sure you talk to a mortgage professional. They can help you determine which loan is best for your unique scenario.
Pros and cons of an adjustable-rate mortgage
|Adjustable-rate mortgage pros||Adjustable-rate mortgage cons|
|Lower interest rates at the beginning of the loan||Riskier, as interest rates and monthly payments could rise later on|
|There’s a chance interest rates could decrease later on||Mortgage payments can be hard to budget for once the rate starts to adjust|
|Good for short-term homeowners||Not good for long-term homeowners|
Adjustable-rate mortgage advantages
Adjustable-rate mortgages have some real risks. But they come with a big advantage, too: adjustable mortgage rates are typically ultra-low at the outset of the loan.
Here’s just one example. According to Freddie Mac, these were the average interest rates for the week of October 14, 2021:
- 30-year fixed-rate mortgage: 3.05%
- 5/1 adjustable-rate mortgage: 2.55%
On a $250,000 mortgage, your monthly principal and payment at 3.05% would be about $850.
If your rate was 2.55%, on the other hand, that monthly P&I payment drops to just $795 — saving you $55 per month or $660 per year.
These initial savings can make adjustable-rate mortgages a great choice for buyers who don’t plan to be in their homes for long.
ARMs usually come with three, five, seven, or 10-year fixed-rate periods — meaning the rate will adjust after that initial period. As long as you plan to sell or refinance before that time is up, you can usually save big, both on your monthly payment and your total interest costs.
Another perk is that adjustable-rate loans don’t always increase over time. In some cases, your rate can actually decrease once it starts to fluctuate. (However, a decrease is typically less likely than an increase.)
Adjustable-rate mortgage dawbacks
Still, that’s about where the perks end. Adjustable-rate loans are risky, and if you stay in the home long enough for your rate to change, it could mean paying more in interest and more monthly than you would on a fixed-rate loan.
They can also be hard to budget for. Though ARMs do come with rate and payment caps in most cases, it can be hard to predict just how much your costs will increase when it comes time for that rate to adjust.
Why would you choose an adjustable rate over a fixed rate?
The right loan type really depends on your finances and your plans as a homeowner.
Here are a few scenarios when you might want to choose an adjustable-rate loan over a more predictable fixed-rate one:
- You plan to move in a few years — If you know you’ll only be in the home for a relatively short time (10 years or less), then an adjustable-rate loan will usually mean a lower interest rate and lower monthly payments. Have a mortgage professional run the numbers for you, of course. But it could save you big in the grand scheme of things
- You know your income will increase in the future — An adjustable-rate loan payment may increase down the line, but if you know you’ll have significantly more income by then, it might not be as worrisome. Remember: ARM rates don’t always increase once they start to fluctuate. In some cases, they may decrease instead. If you have the funds to manage it, an ARM might be worth the risk
- You’re comfortable with refinancing — If you expect to have pretty stable finances and employment over the next few years, you can plan to refinance before your adjustable rate starts to fluctuate. At that point, you could opt for another adjustable-rate loan (getting another low rate) or refinance into a fixed-rate loan for some more consistency. Just be warned: Many adjustable-rate mortgages come with prepayment penalties, so you may owe a fee if you refinance before a certain point
Recap: Fixed vs. adjustable-rate mortgages
Both fixed- and adjustable-rate mortgages can be great in the right situation.
If you value consistency and plan to be in your home for a long time, then a fixed-rate mortgage is likely your best bet. If you want the lowest possible rate and payment, can afford to take a little risk, or only plan to be in the house a few years, an adjustable-rate loan could be a better option.
If you’re not sure which choice is the right move for your budget and goals, talk to an experienced mortgage professional. They can help you run the numbers and determine the best possible route for your home purchase.