Choosing a Fixed-Rate or Adjustable-Rate Loan

Robert Cohan
Featured Image - Choosing a Fixed-Rate or Adjustable-Rate Loan
Share
If you're in the market for a new home or considering refinancing your current mortgage, one of the most significant decisions you'll face is whether to choose a fixed-rate mortgage (FRM) or an adjustable-rate mortgage (ARM). This decision can impact your monthly payments, financial planning, and how much you ultimately pay for your home. To make the right choice, it's essential to understand the key differences between these two loan types and how each can fit into your long-term goals. In this guide, we'll break down the differences between fixed-rate and adjustable-rate mortgages, explain the factors you should consider, and provide clear steps to help you make the best choice for your financial situation.

Understanding the Basics: Fixed-Rate vs. Adjustable-Rate Mortgages

What is a Fixed-Rate Mortgage (FRM)?

A fixed-rate mortgage is exactly what it sounds like: a home loan with an interest rate that remains the same for the entire term of the loan. This means that your monthly mortgage payments for principal and interest will never change, no matter what happens with interest rates in the broader economy. Common Fixed-Rate Mortgage Terms:
  • 30-year fixed-rate mortgage: The most popular option for homeowners, providing stability and predictable monthly payments for three decades.
  • 20-year or 15-year fixed-rate mortgages: These offer lower interest rates but require higher monthly payments since the loan is paid off in a shorter time. If you have substantial equity or a large down payment, these may be attractive options.
The main appeal of a fixed-rate mortgage is predictability. Since the rate doesn't change, you can budget with confidence, knowing that your payment will remain the same over the life of the loan. This is especially helpful if you're planning to stay in your home for a long time or if you prefer financial certainty.

What is an Adjustable-Rate Mortgage (ARM)?

An adjustable-rate mortgage, on the other hand, has an interest rate that can change after an initial fixed-rate period. For example, you might see loans described as "5/1 ARMs" or "7/1 ARMs." In a 5/1 ARM, the interest rate is fixed for the first five years, and then it adjusts annually based on market conditions. Similarly, a 7/1 ARM would have a fixed rate for the first seven years before adjusting. Common ARM Fixed-Rate Periods:
  • 5/1 ARM: The rate is fixed for five years, then adjusts yearly.
  • 7/1 ARM: The rate is fixed for seven years, then adjusts yearly.
  • 10/1 ARM: The rate is fixed for ten years, then adjusts yearly.
After the fixed-rate period ends, your interest rate can go up or down depending on how broader interest rates in the economy fluctuate. This can make your monthly payments unpredictable, especially if interest rates rise significantly. However, the initial interest rate on an ARM is usually lower than that of a fixed-rate mortgage, which can make it an appealing choice for certain buyers.

Factors to Consider When Choosing Between Fixed-Rate and Adjustable-Rate Mortgages

The decision between a fixed-rate and an adjustable-rate mortgage isn’t just about picking whichever sounds better on the surface. There are a variety of personal factors that should influence your choice. Consider the following:

1. How Long Do You Plan to Stay in the Home?

Your timeline for living in the home is one of the most critical factors in choosing between an FRM and an ARM. If you’re fairly certain you’ll move within a set number of years (for instance, if you plan to relocate for work or upgrade as your family grows), an ARM could be a smart option. You can take advantage of the lower initial rate, and if you sell before the rate adjusts, you’ll never experience the higher payments. However, if you plan to stay in your home for the long haul—say 10, 15, or 30 years—a fixed-rate mortgage may be better. You'll have the stability of knowing your payments won’t change, even if interest rates increase. Quick Tip: Match the ARM's fixed period to your expected timeline for living in the home. For instance, if you're planning to move in five years, a 5/1 ARM might work well for you.

2. Can Your Budget Handle Payment Increases?

With a fixed-rate mortgage, you’ll know exactly what your payments will be for the life of the loan, making it easier to budget and plan for the future. This stability is a big reason why fixed-rate mortgages are so popular. With an adjustable-rate mortgage, on the other hand, your payments can change after the initial fixed period. While the initial rate is usually lower, there's a risk that your payments could increase significantly if interest rates rise. Before choosing an ARM, consider whether your budget could handle higher payments in the future. This is especially important if you’re at the beginning of your career or expect your income to fluctuate in the coming years. Consider This: If you’re early in your career and expect significant raises or promotions, an ARM might be less risky. But if your income is unlikely to increase, the unpredictability of an ARM could be financially challenging.

3. What Are the Current Market Conditions?

In periods of rising interest rates, a fixed-rate mortgage can provide protection against future increases. On the other hand, if rates are high and expected to drop, an ARM can allow you to take advantage of future rate decreases, as your rate will adjust downward after the initial period. It’s essential to consider both the current interest rate environment and your long-term financial strategy when making this decision. You can work with your lender to assess whether current rates are favorable for a fixed-rate mortgage or if an ARM would be more advantageous given potential rate trends.

4. How Do You Feel About Risk?

Choosing between a fixed-rate and adjustable-rate mortgage also comes down to how comfortable you are with financial risk.
  • Fixed-Rate Mortgages are great for those who prefer stability and predictability. If you don’t want to worry about fluctuating rates and unpredictable payments, a fixed-rate mortgage can provide peace of mind.
  • Adjustable-Rate Mortgages are suitable for more risk-tolerant individuals. If you're comfortable with the idea of changing payments and have flexibility in your budget, an ARM could offer savings during the initial fixed period.

5. Are There Caps on How Much the Rate Can Change?

If you’re considering an adjustable-rate mortgage, it’s crucial to understand the caps that limit how much your interest rate can change. There are three types of caps you should be aware of:
  • Initial Adjustment Cap: This limits how much your rate can increase the first time it adjusts after the fixed-rate period ends.
  • Subsequent Adjustment Cap: This limits how much your rate can increase at each subsequent adjustment period.
  • Lifetime Cap: This is the maximum amount your interest rate can increase over the life of the loan.
Make sure you fully understand these caps and how they could affect your payments if interest rates rise.

Steps to Make the Best Choice for Your Mortgage

Now that you understand the key differences between fixed-rate and adjustable-rate mortgages, it’s time to take the next steps to determine which loan type is best for your financial situation.

Step 1: Ask Yourself Key Questions

Before making any decisions, ask yourself the following questions:
  • How long do I plan to stay in this home? If you're not planning to stay for more than five to ten years, an ARM could be a great way to save on interest during that time.
  • What does my long-term budget look like? Do you expect significant changes in your income, expenses, or family situation? These factors can all influence which mortgage makes the most sense for you.
  • Am I comfortable with the idea of rate changes? If the thought of changing mortgage payments makes you uneasy, a fixed-rate mortgage might be the better option.

Step 2: Speak With a Mortgage Expert

Once you have a clear sense of your goals and financial situation, the next step is to meet with a mortgage expert. They can help you evaluate both fixed-rate and adjustable-rate options, and determine which is the best fit for your needs. At Carlyle Financial, we’re here to guide you through the decision-making process. Our mortgage bankers will review your financial objectives, discuss current interest rates, and help you weigh the pros and cons of each type of loan. We’ll ensure you have all the information you need to make a confident, informed decision.

Step 3: Understand the Details of Your Loan

Whether you choose a fixed-rate or adjustable-rate mortgage, make sure you fully understand the terms and conditions of your loan. Pay attention to:
  • The interest rate (and how it may change with an ARM)
  • The length of the loan
  • Any penalties or fees associated with prepayment or refinancing
  • Caps on rate adjustments (for ARMs)
Knowing these details will help you plan for the future and avoid any surprises down the road.

Making the Right Choice for Your Mortgage

Choosing between a fixed-rate and an adjustable-rate mortgage is a significant decision that depends on your financial goals, timeline, and risk tolerance. By carefully considering how long you plan to stay in your home, your budget, and your comfort level with rate changes, you can make the choice that’s best for you. Still not sure which loan type is right for you? Contact Carlyle Financial today to speak with one of our experienced mortgage bankers. We’ll guide you through every step of the process, so you can make an informed decision and feel confident in your mortgage choice. By working with a knowledgeable lender and understanding your own financial goals, you can secure the mortgage that best fits your needs, whether it
Get All Your Jumbo Mortgage Questions Answered

Connect with our mortgage experts today so you can be one step closer to your dream home!

Tags:

Learn about the benefits of refinancing your home

Learn More

Robert Cohan

Robert Cohan is driven by a belief that solutions aren’t just found – they are carefully crafted. As…
President
San Francisco
Message
Robert’s Blogs
Read more

California Home Buying: When is the Right Time?

Read more

California Jumbo Loans: What You Need to Know!

Read more

7 Popular Mortgages to Explore When Buying a Home

Read more

Navigating Mortgage Rates: The Role of Property Type

About Robert Cohan

Robert Cohan is driven by a belief that solutions aren’t just found – they are carefully crafted. As President of Carlyle Financial, he ensures that the firm’s mortgage solutions are elegantly simple, yet flexible enough to provide custom options for our clients.

Robert is an experienced mortgage professional and industry innovator. He developed his passion for providing extraordinary service for extraordinary clients as a top mortgage professional for several national banks, including Bank of America, Washington Mutual (now J.P. Morgan Chase) and Wells Fargo Home Mortgage, where he became the first loan officer to open a mortgage-only storefront on Canon Drive in the heart of the Beverly Hills triangle.

After working with hundreds of clients at multiple national and regional banks, Robert saw the limitations of the big bank mono-channel model and developed his own lending and service philosophy. His trailblazing approach led to the founding of Carlyle Financial, where he could continue his commitment to customized home loans while changing the way his clients experienced the mortgage process. He is based in the San Francisco headquarters at One Market Plaza.

Robert has been recognized as a leading jumbo mortgage expert in The Wall Street Journal, Business Insider, Investor’s Business Daily, and many other publications. He is also active in his community, committing time and resources to causes that align with his philanthropic values. When he isn’t helping clients structure their next home, you can find Robert on the basketball court coaching youth league kids on their jump shot.