ARM vs Conventional Loans

ARM vs Conventional Loans

JR Mortgage Group Inc.
JR Mortgage Group Inc.
Published on November 8, 2022

ARM vs Conventional Loans

ARM vs. Conventional Loans

For those seeking to purchase a home, there are many questions that arise throughout the process, including whether to choose an adjustable or fixed-rate mortgage. While there are pros and cons to each, the right loan for you depends on various factors, including length, current interest rates, and your budget, so understanding what each one entails is essential. Let’s take a closer look at adjustable-rate mortgages and conventional fixed-rate options so you can choose the one that’s right for you.

 

What is an ARM and a Conventional Loan?

To make an informed decision on which loan is right for you, it helps to understand what the options are.

 

Adjustable Rate Mortgage (ARM)

An Adjustable Rate Mortgage is a long-term loan option that offers fifteen, twenty, or thirty-year length options for homeowners. Several varieties are available, but they all follow the same general interest guidelines of a fixed-rate period followed by a variable-rate period.

ARMs are listed showing both of these time periods in the form of #/#m, so you can quickly know what to expect when choosing one. For example, an ARM listing with 6/6m means you have a six-year fixed-rate time period. Once that time is completed, you will have a floating rate that may change every six months, which is known as the adjustment period. During the adjustment period, the rate is determined by the Secured Oversite Financing Rate (SOFR) and is almost always based on the following formula:

 

30-day SOFR average (Index) + (Margin)

Typically, the margin ranges between 2.74% and 2.76% and will remain constant, while the SOFR index value will vary.

The New York Federal Reserve is responsible for maintaining the SOFR index and, as of early 2022, the average thirty-day rate was 0.0487%. To view current rates, click here.

One of the biggest advantages of selecting an ARM is its lower rates compared to conventional fixed-rate loans. Although usually around less than one percent, this difference becomes considerable over the length of the fixed-rate period.

The disadvantages to an ARM appear once the fixed-rate period ends and the adjustable rate begins. If the newly-calculated rate is higher than the previously fixed one, your mortgage payment may increase, an unwelcome reality to many homeowners. While there is a cap on how much this rate can rise, it can still bring significantly higher monthly payments.
Conventional Loans

Fixed-rate, or conventional, loans are easier to understand, which can help make the process simple for first-time homeowners. Once your rate is set, it will remain the same for the entire length of the mortgage. Generally, fixed-rate mortgages have fifteen or thirty-year options, providing homeowners with different payment plans.

The speed at which a fixed-rate mortgage can be repaid has pros and cons itself, all depending on your initial interest rate. Due to the market over the last few years, many homeowners have chosen a fixed-rate loan over an ARM, capitalizing on the lower payments with a faster repayment, but it’s important to speak to a trusted broker that will help you decide which option is right for you.

 

 

The Key Differences

The main difference between an ARM and a conventional or fixed-rate loan is the length of the interest rate fixation. With an ARM, the fixed rate only covers part of the loan length, while the remainder of the time is under an adjustable rate. Your rate can rise once in the adjustable portion of your loan, but there is a cap set by the SOFR index. It is important to note that while the rise (or fall) of the rate may only be a small percentage, this could significantly impact your monthly payment amount. Those who prefer knowing what their monthly mortgage payment will be every month may not find that an ARM is a good fit.

To better decide which loan is right for you, it helps to understand the caps on ARM interest rates. The Consumer Finance Protection Bureau reports the rates below as the most commonly seen adjustment amounts.

2% – 5% – This percentage is most common for your initial adjustment cap and indicates how much your rate will increase when the loan transitions from a fixed to an adjustable rate.

2% – The most common increase amount to your rate after every adjustment period.

5% – The most commonly seen increase above the initial fixed rate amount during the life of your loan.

 

It’s vital to know the caps on your adjustable-rate mortgage to determine the amount of interest you may pay over the life of the loan.

 

Choosing The Right Loan For You

While there are many factors that go into considering which loan is right for you, there is one that is often the determining factor: the length of time you will stay in your home. If you plan to move in three-to-ten years, you may want to choose an ARM thanks to its lower initial fixed rate; but if you are purchasing your forever home, a fixed-rate or conventional loan may be right for you.

Choosing a loan is a difficult decision, which is why having an experienced mortgage brokerage to walk you through your options is essential. JR Mortgage Group will work with you every step of the way, making purchasing the home of your dreams easier than ever.

Visit www.jrmortgagegroup.com or call 316-247-9639 to get in touch with one of our mortgage brokers today!

 

JR Mortgage Group Inc.
JR Mortgage Group Inc.
Click to Call or Text:
(316) 247-9639

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