A mortgage loan not insured by any government program, conventional loans are the most common type of mortgage. They differ from FHA loans and VA loans which are insured by the government. Conforming conventional loans follow the loan amount guidelines set by Fannie Mae and Freddie Mac. Nonconforming loans don't meet those qualifications, but are also considered conventional. Each mortgage lender, bank or mortgage broker will offer different rates, terms and fees for conventional loans, so it's best to get Good Faith Estimates from a number of different places to find the best loan.
Fixed-Rate Mortgage
A Fixed-Rate Mortgage is a mortgage that has a static interest rate for the entire life of the loan, and offers a straightforward, consistent monthly payment. The distinctive factor of a fixed rate mortgage is that your interest rate will be defined at the time your mortgage is originated and will not change over the term of the loan. The consistent monthly payment and rate will allow you to better budget based on this fixed cost.
A Fixed-Rate Mortgage may be a good choice if you:
- Think interest rates could rise in the next few years and want to take advantage of current rates
- Plan to stay in your home for many years
- Prefer the stability of a fixed monthly interest payment rather than a payment that changes periodically (which is the case with an Adjustable-Rate Mortgage)
Adjustable-Rate Mortgage (ARM)
An Adjustable-Rate Mortgage, commonly referred to as an “ARM”, is a mortgage loan with an interest rate that changes usually based on an index. As a result of the adjusting interest rate, your monthly payments will also change periodically. While lenders may offer lower initial interest rates for ARMs, It’s important to recognize to weigh the risk that an increase in interest rates could lead to higher monthly payments in the future.The initial rate and payment on an ARM will remain the same for a limited period of time. Most ARM rates and payments will adjust every 3, 5, 7 or 10 years. For example, a 3-year ARM will have an “adjustment period” once every three years. Interest rates on an ARM are made up of the index and margin. The index is a measure of interest rates and the margin is an additional amount that the lender adds. Payments on an ARM will be affected by the caps, or limits, that establish how high or low your rate can go.
Not all ARMs will adjust downward so be sure to read the fine print, however, in most cases the relationship between indexes, rates and payments are as shown below:
An Adjustable-Rate Mortgage (ARM) may be a good choice if you need to:
- Save money on interest payments
- Lower monthly mortgage payments
- Consolidate other debts
- Invest in home improvements
- Reduce the term of your mortgage and save money long term
Some things to consider before choosing an ARM…
- If interest rates do rise, is my current income sufficient to cover higher mortgage payments?
- Will I be taking on other sizable debts, such as a loan for a car or school tuition, in the near future?
- How long do I plan to own this home? (If you plan to sell soon, rising interest rates may not pose the problem they do if you plan to own the house for a long time.)
- Do I plan to make any additional payments or pay the loan off early?