10/1 ARM vs 30 Year Fixed Mortgage

Whether you’re buying a home or refinancing, it’s important to understand your primary financing options, including how current interest rates will affect your loan and monthly payments. In many cases, you can choose between a fixed-rate mortgage or an adjustable-rate mortgage (ARM). Making the right choice could change the final cost of your mortgage to the tune of many, many thousands of dollars. 

So, what is an ARM? Is it something you should consider? What are the positives and negatives of this type of financing? Would a fixed-rate loan be the better option? 

Read on to learn everything you need to know about ARM vs fixed rate mortgages.

What is an ARM?

An ARM is short for an adjustable-rate mortgage. As the name implies, this type of mortgage means that you have a variable (meaning, not fixed) interest rate. That means, the rate will adjust, or change, over time. The general naming convention for an ARM includes two numbers – for example, you can get a 1/1, 3/1, 5/1, 7/1, 10/1, or even a 10/6 ARM (Island Federal does not offer the 10/6 ARM).

The first number in an ARM shows how many years the rate is fixed at the beginning of the loan. The second shows how frequently the rate can adjust (up or down) after that period.

Difference between 10/6 ARM vs. 10/1 ARM

To further explain what is a 10/1 ARM vs a 10/6 ARM, while both will offer a fixed rate for the first 10 years of the loan, after that, the rate will adjust every one year in the 10/1 case or every six months in the 10/6 case. 

Conversely, a 10/1 ARM includes a fixed interest rate for the first decade but will update every year after that. Adjustments to the interest rate will depend on several factors, including federal interest rates and market conditions, when the adjustment takes place.

Pros of an ARM

ARM’s offer a few advantages, which is why some homeowners choose them. They’re not as popular as fixed-rate loans based on the percentage share of mortgage loans over the years, but they still have their place and can be advantageous under very specific circumstances.

• Potentially lower rates:  For starters, ARM’s typically offer lower rates than a fixed rate mortgage will in the initial years of the loan. This means they can save homeowners thousands of dollars in interest during that time frame.
• Rates might decrease: A second advantage is that an ARM rate can potentially go lower over the course of the loan. If you take out the mortgage during a period of high interest rates, the rates might go down after the initial fixed period.
• Good for short-term purchases: Lastly, depending on where rates are when the loan is taken out, ARM’s can be ideal for homeowners who don’t plan to be in a property for long. If you know that you won’t want to keep a house for longer than 10 years, you might be able to enjoy a lower rate and sell before the rate adjusts – just make sure you don’t have a loan with a prepayment penalty. 

Cons of an ARM

Like most things in life, nothing is all good. This is true in the case of ARM’s, too. Understanding the potential drawbacks to this type of financing will help you make a smart decision.

• Your rate isn’t guaranteed: The adjusted rate can go up. If that happens, the ARM can become a costly mortgage option – sometimes by substantial amounts.
• It’s a gamble: No one likes uncertainty. Having an ARM means you don’t know your interest rate in the future, and thus, you can’t possibly know the true total cost of the mortgage.
• Complicated financing option: ARM loans are more complicated. Sometimes caps don’t apply to the full adjustment, and plenty of other factors can make these loans confusing, making it difficult to know for sure if you’re getting the most out of the deal.

What is a Fixed-Rate Mortgage?

A fixed-rate mortgage is exactly what the name implies. You take out a loan for a specific amount, and the annualized interest rate on that mortgage is set in stone. The term of the loan can vary, usually from 10 to 30 years, with the 30-year loan being the most popular. 

Fixed-rate loans can offer stability and the ability to plan, which can be comforting, especially for first-time or nervous borrowers. 

Pros of a Fixed-Rate

30-year fixed loans are the most popular type of mortgage. There are a few good reasons for that.

• Potentially lower overall cost of a loan: Even with the threat of inflation (and the actuality of the Fed recently raising rates), interest rates have been historically low since about 2010. Locking in a low interest rate for the whole term of a loan can save borrowers tens of thousands of dollars by the time all is said and done.
• Same payment for life of the loan: Fixed-rate loans are predictable, meaning the principal and interest portion of the mortgage payments stay the same for the life of the loan, as long as you don’t refinance. It can be much easier to plan around this stability.
• Simplicity can be rewarding: The simplicity of a fixed-rate loan means you won’t accidentally miss market caps and other potential advantages. You just lock in a payment and keep up with it.

Cons of a Fixed-Rate

Even though 30-year fixed mortgages are more common, they aren’t always the best choice. They come with some disadvantages that are important to understand.

• If rates go down, you don’t benefit: Because the rate is fixed, if interest rates go down, you’ll essentially be losing money. You have to refinance if you want to take advantage of lower rates.
• Higher rates: The interest rates are typically higher on these loans when compared to the initial rates of an ARM. You’re paying for predictability.

The Difference Between ARMs and Fixed-Rate Mortgages

The main differences between a 10/6 ARM or 10/1 ARM vs 30-year fixed mortgages just come down to interest rates and monthly payments. 

Fixed-rate mortgages will have higher interest rates than ARM loans at the time the loan is signed. And longer fixed-rate loans (for example, a 30-year vs a 15-year loan) will have higher interest rates as well. Keep in mind, though, despite a 15-year loan’s lower rate, the shorter loan will still have higher monthly payments in order to pay the loan off faster. 

Any type of adjustable-rate loan – a 10/1 ARM or a 10/6 ARM or any other type of ARM – will come with the risk that rates will be higher down the road. When (or if) this happens, your loan will become considerably more expensive.

Choosing an ARM or Fixed Rate Mortgage

When it comes to choosing between a 10/1 ARM vs a 30-year fixed, you’re weighing stability and predictability against the chance to save money. In short, it’s a gamble. If you’re only expecting to pay on a loan for 10 to 15 years, an ARM might be the better option. If you think you’ll be with a loan for the long haul, considering a fixed rate loan might be the safer choice.

Final Thoughts

When you understand your different loan options – from a 10/1 ARM, to a 5/1 ARM, to a fixed-rate loan – you can make an informed (and thus, less risky) decision about the money you’re borrowing. At the end of the day, mortgaging a property is an investment, and investing always involves risk. Being as knowledgeable as possible can mitigate a lot of the risk you might be taking. 

Figure out what your payment might be on any loan using our virtual financial calculator tool. Island Federal makes the process of borrowing money simple, affordable, and convenient. Learn more about our financing options today.