Family Trust Blog

Fixed-Rate vs Adjustable-Rate Mortgages: Key Differences

When you're shopping for a home loan, one of the first decisions you'll face is choosing between a fixed-rate mortgage and an adjustable-rate mortgage. Both can be the right choice depending on your situation, but they work very differently. Understanding those differences before you commit can save you a significant amount of money and stress over the life of your loan.

Here's what you need to know.

How a Fixed-Rate Mortgage Works

With a fixed-rate mortgage, your interest rate stays the same for the entire life of the loan. Whether you choose a 15-year or 30-year term, the rate you lock in on closing day is the rate you'll pay on your last monthly payment.

This consistency makes budgeting straightforward. Your principal and interest payment never changes, so you always know exactly what to expect. The only parts of your monthly payment that may shift over time are property taxes and insurance, which are typically collected through your escrow account.

Fixed-rate mortgages tend to be the most popular choice among homebuyers, largely because of that predictability.

How an Adjustable-Rate Mortgage Works

An adjustable-rate mortgage, commonly called an ARM, starts with a fixed interest rate for an initial period, then adjusts periodically based on market conditions. The initial fixed period is typically 3, 5, 7, or 10 years. After that period ends, the rate can go up or down depending on the index it's tied to.

ARMs are often described with a set of numbers, like 5/1 or 7/6. Here's how to read those:

• The first number is the length of the initial fixed-rate period in years
• The second number is how often the rate adjusts after that period (1 = annually, 6 = every six months)

So a 5/1 ARM has a fixed rate for the first five years, then adjusts once per year after that.

Rate Caps on ARMs

To protect borrowers from dramatic payment increases, ARMs come with rate caps that limit how much the interest rate can change. There are typically three types:

1. Initial cap: The maximum the rate can increase at the first adjustment
2. Periodic cap: The maximum it can increase at each subsequent adjustment
3. Lifetime cap: The maximum it can ever increase over the life of the loan

For example, a 2/2/5 cap structure means the rate can increase no more than 2% at the first adjustment, 2% at each adjustment after that, and no more than 5% total over the life of the loan.

Side-by-Side Comparison

Who Is a Fixed-Rate Mortgage Best For?

A fixed-rate mortgage tends to be the better fit if you:

• Plan to stay in your home for many years
• Prefer the security of a payment that never changes
• Are buying when interest rates are relatively low and want to lock that rate in
• Have a budget that doesn't have much flexibility for payment fluctuations

The trade-off is that fixed rates are typically higher than the initial rate on an ARM. You're paying for the stability and peace of mind that comes with knowing your rate is set for good.

Who Is an Adjustable-Rate Mortgage Best For?

An ARM can make sense in certain circumstances. It may be worth considering if you:

• Plan to sell or refinance before the initial fixed period ends
• Expect interest rates to drop in the coming years
• Want a lower initial monthly payment to free up cash in the short term
• Are confident your income will grow enough to handle potential rate increases down the road

The key risk with an ARM is uncertainty. If rates rise significantly after your fixed period ends, your payment could increase in ways that strain your budget. Going in with a clear plan for how long you'll be in the home is important.

A Quick Example

Here's how the two options might compare on a $250,000 loan:

The ARM saves nearly $200 per month in the early years. But if rates climb significantly after year five, those savings can disappear quickly.

Questions to Ask Before You Decide

Before choosing between a fixed or adjustable rate, it helps to work through a few key questions:

• How long do I realistically plan to stay in this home?
• How would my budget handle a payment increase of $200, $300, or more per month?
• Where are interest rates today relative to historical averages?
• Is there a chance I'll need to refinance in the next few years anyway?

There's no universally right answer. The best mortgage is the one that aligns with your plans, your budget, and your comfort level with risk.

Talk It Through With a Local Expert

Reading about mortgages is a good start, but nothing replaces a conversation with someone who knows the local market and can look at your specific financial picture. At Family Trust, our mortgage team works with members one-on-one to help you understand your options and choose the loan that makes the most sense for you. We've been helping families in York County and across the Upstate navigate the homebuying process for nearly 70 years.

Ready to Explore Your Mortgage Options?

Visit our mortgage loans page to learn more about what Family Trust offers, or use our financial calculators to compare payment scenarios side by side. Stop by any of our branch locations or give us a call at (803) 367-4100 to get started.