Are Conventional Loans Fixed-Rate or Adjustable?

A conventional loan is a mortgage option for financing a home purchase. It is provided by private lenders, such as banks, credit unions, and mortgage companies, rather than being insured or guaranteed by a government agency. Conventional loans can have either a fixed or adjustable interest rate, offering borrowers different payment predictability. The choice depends on financial circumstances and personal preferences.

Understanding Conventional Loans

Conventional loans are home mortgages not backed by federal government agencies like the FHA, VA, or USDA. Private financial institutions originate these loans, adhering to guidelines set by government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac. Meeting these conforming loan limits allows lenders to sell mortgages on the secondary market, ensuring funds for new loans. While conventional loans often have stricter qualifying criteria than government-backed options, they offer flexibility in loan sizes and property types.

Fixed-Rate Conventional Loans

A fixed-rate conventional loan features an interest rate that remains constant throughout the loan’s duration. This stability means the principal and interest portion of the monthly mortgage payment will not change. The consistent payment simplifies budgeting and provides predictability. Common fixed-rate terms include 15-year and 30-year periods.

With a fixed rate, the initial interest rate is locked in at loan closing, regardless of future market fluctuations. This safeguards against rising interest rates, ensuring monthly payments remain manageable. However, if market rates decline, the borrower would need to refinance to take advantage of lower rates.

Adjustable-Rate Conventional Loans

An adjustable-rate conventional loan (ARM) begins with an initial fixed interest rate for a specific period, after which the rate can change periodically. This initial fixed-rate period typically ranges from three to ten years, with common terms such as 5/1, 7/1, or 10/1 ARMs. The first number indicates the fixed-rate period in years, while the second denotes how often the rate adjusts, usually annually. After the fixed period, the interest rate fluctuates based on a financial index plus a fixed margin set by the lender.

ARMs include interest rate caps that limit how much the rate can increase or decrease during adjustments and over the loan’s lifetime. An initial adjustment cap restricts the first change, while periodic caps limit subsequent changes, often by one or two percentage points. A lifetime cap sets the maximum interest rate that can be charged over the entire loan term, commonly around five or six percentage points above the initial rate. These caps provide protection against extreme payment increases, though monthly payments can still vary.

Deciding Between Rate Types

Choosing between a fixed-rate and an adjustable-rate conventional loan involves several personal and market factors. The length of time a borrower plans to stay in the home is a key consideration. Those expecting to move within a few years might find an ARM’s initial lower rate appealing, potentially selling before the rate adjusts. Individuals planning to remain in their home longer often prefer the stability and predictability of a fixed-rate mortgage.

The prevailing interest rate environment also influences this decision. In high interest rate periods, an ARM might offer a more affordable initial payment, with the hope that rates will decline. When current rates are low, locking in a fixed rate provides long-term payment security. A borrower’s comfort level with potential payment fluctuations, or risk tolerance, plays a role. A fixed rate provides peace of mind through consistent payments, while an ARM carries the risk of increased costs. Financial stability, including a steady income, is also important for managing possible payment increases with an adjustable-rate loan.