Here’s an interesting question: “Which mortgage has the best interest rate?”
Before we dive in, the “best” questions are always a bit difficult to answer universally because what is best for one person may be worst for another. Or at least not the best.
This is especially true when talking about mortgage questions, which tend to be a bit more complex.
But we can still talk about what makes one mortgage rate on one product better than another, in certain situations.
In a recent post, I mentioned the different mortgage terms available, like 30 years, 15 years, etc.
That was also a “better” article, in which I tried to explain what mortgage term it would be best in a particular situation.
Related to that is the associate mortgage interest rate that comes with a specified loan term. Together, they can drive your decision on your desired mortgage product.
Longer loan term = Higher mortgage rate
- The longer the mortgage rate is fixed
- The higher the interest rate, everything else will be the same
- This compensates the lender (or their investor) for taking more risks.
- Because they are settling for a certain interest rate over a longer period of time.
Now I am going to assume that by the best you mean the lowest, so we will focus on that definition, even if it is not the best for you. By the way, a lot of puns went through, but I’m trying to ignore them.
Simply put, a longer mortgage term generally translates to a higher mortgage rate.
then a 10-year fixed rate mortgage it will be much cheaper than a 40-year fixed loan for two borrowers with similar credit profiles and credit needs.
In addition, a adjustable rate mortgage it will generally be priced lower than a fixed rate loan, as you are guaranteed a constant rate throughout the term of the fixed rate loan.
All of this has to do with risk: a mortgage lender It essentially offers you an upfront discount on an ARM in exchange for future uncertainty.
With the fixed rate loan, nothing changes, so you are paying full price, if not a premium, for your peace of mind in the future.
If the interest rate is fixed, the short-term loan will be cheaper because the lender does not have to worry about where the rates will be in 20 or 30 years.
For example, they may offer you a lower mortgage rate for a 10-year term versus a 30-year term because the loan will pay off in a decade instead of three.
After all, if rates increase and triple in 10 years, they won’t be thrilled with your super low rate that’s set for another 20 years.
All of that is pretty straightforward, but knowing which one to choose could be a bit more overwhelming and may require dusting off a mortgage calculator.
Mortgage interest rates from cheapest to most expensive
- 1 month ARM (the cheapest)
- 6-month ARM
- 1-year ARM
- 10 year fixed
- 15 years fixed
- 3-year ARM
- 5-year ARM
- 7 year ARM
- 10 year ARM
- 30 years fixed
- 40 years fixed (more expensive)
Now this can definitely vary from bank to bank, but it is a rough order of how mortgage rates could be set from low to high, at least in my opinion.
Many lenders don’t even offer all of these products, especially very short-term ARMs, but you can get an idea of what is cheaper and more expensive based on your term and / or how long you lock in.
Currently the very popular 30 years fixed It is priced at around 2.50%, while the 15-year fixed rate is at 1.875%, based on my own research of the latest mortgage rate data.
The 5/1 Hybrid ARM, which is fixed for the first five years and adjustable for the remaining 25 years, averages 2.125% slightly lower compared to the 30-year fixed.
The cheapest conventional product is the 10-year fixed, which averages around 1.75% because the term is very short.
But let’s focus on the 30-year fixed ARM and the 5-year ARM, as they are the most popular in their respective categories.
As you can see, the 30-year fixed is the most expensive in the table above. In fact, it’s almost half a percentage point higher than the average rate on a 5/1 ARM.
This margin can and will vary over time, and at this time it is not very wide, which means that the ARM discount is not great.
At other times, there may be a difference of one percent or more, which makes the ARM much more attractive.
Regardless, on a $ 200,000 loan, that would be about a $ 40 difference in monthly payments. mortgage payment and about $ 2,280 over five years.
For the record, a 3/1 ARM o One-year ARM would be even cheaper, though probably only slightly. And for a loan that adjusts every three years or annually, it’s a great risk in an environment where interest rates are likely to be at or near the minimum.
As mentioned, the low initial rate in the 5/1 ARM it is only guaranteed for five years, and then becomes adjustable annually for the remainder of the term. They are many years of uncertainty. In fact, it is 25 years of risk.
The 30-year fixed is, well, fixed. Therefore, it will not increase or decrease at any time during the term of the loan.
The ARM has the potential to fall, but that’s probably unlikely given where rates are historically. And lenders often impose minimum levels on interest rates that limit any potential improvement in interest rates.
So what is the best mortgage rate?
- The best mortgage rate is the one that saves you the most money.
- Once you factor in the monthly payment, closing costs, and interest expense
- Along with what your money could be doing elsewhere if invested
- And what are your plans with the underlying property (how long do you plan to keep it, etc.)
The best interest rate? Well, that depends on a number of factors unique to you and only you.
Are you planning to stay in the property for the long term, or is it a starter home that you think will discharge in a few years once it gets too small for you?
And is there a better place for your money, like the stock market or other high-yield investment?
If you plan to sell your home in the medium or short term, you can go for an ARM and use those monthly savings for a initial payment in the purchase of a subsequent home.
Just make sure you have enough money to make bigger monthly payments if your ARM is adjusted higher if you don’t actually sell or refinance your mortgage before that.
Five years of interest rate stability is not enough? Examine 7/1 and ARM 10/1, which are not adjusted until after the seventh and tenth years, respectively.
That’s quite a long time, and the discount relative to a 30-year fixed might well be worth it. Just expect a smaller one relative to short-term ARMs.
But if you just don’t like stress and / or can’t take chances, a fixed-rate mortgage is probably the only way to go.
Short-term mortgages such as 15-year mortgages are the best offer
If you have a lot of money and you really want pay off your mortgage early, a 15-year flat rate will be the best deal, as you will get the lowest flat rate available. And as noted, a 10-year landline can be even cheaper.
The shorter term also means that less interest will be paid to the lender. The downside is the higher monthly payment, something not all homeowners can afford.
As a general rule of thumb, when interest rates are low, it makes sense to lock in a fixed rate, especially if the ARM discount isn’t much.
Conversely, if interest rates are high, it may make sense to take the initial discount with an ARM.
In the event that rates have dropped when it’s time to refinance (after the initial fixed period ends), you could do very well.
And even if rates drop shortly after you get your mortgage, you can always refinance to another ARM, thus extending your fixed period a bit longer.
Or just swap your ARM for a fixed rate mortgage if the rates are really good during that time.
The flip side of the coin is that rates could keep going up, putting you in a tough spot if your ARM adjusts higher and interest rates aren’t favorable at refinance time.
Ultimately, you are always taking a risk with an ARM, although you could also be leaving money on the table with the fixed-rate loan, especially if you don’t keep it close to term.
Either way, watch closing costs and be wary of reset your mortgage clock if your end goal is to pay it off in full.
In the end, it may all come down to what is comfortable for you.
For many, the stress of an ARM is simply not worth any potential discounts, so perhaps a fixed mortgage is “for the best,” especially with how cheap they are these days.
Read more: Which Mortgage Is Right For Me??