Conventional mortgage vs. FHA
Learn the differences between a conventional mortgage and an FHA when it comes to loan requirements, down payments and credit scores.
Ashley Eneriz
Before you can pick out a new couch or area rug for your new home, you will need to choose a mortgage term. Most mortgage loans can come as either a fixed-rate mortgage or an adjustable-rate mortgage (ARM).
Alex Shekhtman, the CEO of LBC Mortgage, explained the difference between the two this way: “Let's start with the fixed-rate mortgage. It's like having a steady ship in a stormy sea. The interest rate stays the same for the entire loan, whether it's 15, 20 or 30 years. This type is great if you like knowing exactly what you'll pay every month.”
Shekhtman compared an ARM to a roller coaster, saying: “At the beginning — usually for 5, 7 or 10 years, the interest rate stays put. But after that, it can change based on a special number and a set extra amount. Keep in mind that your payments could go up later on.”
The appeal of adjustable-rate mortgages is that the initial interest rate is typically lower than the current market rate and lower than the lender’s option for fixed-rate terms. The initial fixed-rate period can vary based on lender offerings.
You will typically see it called 5/1 ARM or 10/1 ARM (or similar variations thereof, such as 3/1 or 7/1). This means the first five or 10 years are fixed, and then the new rate is reevaluated each year based on market conditions.
After the initial period of a fixed rate, the new rate can go either up or down. Most loans will have interest rate caps, though, so homeowners are protected from extreme fluctuations.
Shekhtman said ARMs are a good choice if:
ARMs are a good choice for buyers who want to secure a lower interest rate out of the gate. If you sell or refinance your property before this time limit, you can save a lot on the total interest cost and monthly payment.
ARMs can be risky, though. If you occupy the property long enough for the rate to increase significantly, you’ll have to pay more overall in monthly payments and interest.
Consider these pros and cons before deciding on an ARM for your home.
When you opt for a fixed-rate mortgage, you’ll pay a set interest rate that remains unchanged throughout the life of your loan. Though the monthly interest and principal vary in terms of payments, the total monthly payment doesn’t change. This makes budgeting easier to manage.
Fixed-rate mortgages typically come in 15- or 30-year terms, though some lenders might offer an option to choose your loan term. The longer the term, the lower your monthly payments will be, but expect to pay more in the long run for interest.
Shekhtman said fixed-rate mortgages are a good choice if:
Most people choose a fixed-rate mortgage because it’s straightforward, consistent and more stable than an ARM. With a fixed-rate loan, there are no surprise rate increases, and budgeting is simpler.
One downside: Rates for this type of loan tend to be higher than what ARMs offer during the initial years. That means you have to pay a higher monthly payment and interest rate at the beginning, which isn’t to your benefit if you only plan to spend a short time in the property.
Weigh the fixed-rate mortgage pros and cons to see if it is a good fit for you.
» MORE: How much house can I afford?
Yes, government-backed loans like FHA, VA and USDA loans are available as adjustable-rate mortgages. However, terms and availability will vary by lender.
Some lenders offer options to convert an ARM into a fixed-rate mortgage, usually at a predetermined time and for a fee. If your lender does not offer this option, you can always refinance your ARM into a new fixed-rate mortgage loan.
Yes. Many fixed-rate mortgages and ARMs allow borrowers to pay off the loan early without prepayment penalties. You will want to check with your lender to make sure there are no fees or rules regarding accelerating your mortgage repayment.
Both adjustable- and fixed-rate mortgages are good options in specific situations. If you plan to live in the property you’re buying for a long time, a fixed-rate mortgage can save you money and offer a sense of stability and consistency.
However, if you plan to stay in the property for a limited time and want the lowest monthly payment and rate to start, an ARM could be a good option for you.
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