Here’s an interesting question: “Which mortgage has the best interest rate?”
Before we go any further, it’s always a little difficult to universally answer the “best” questions. What is best for one person may be worst for another. Or at least not exactly the best.
This is especially true when discussing mortgage questions, which tend to be a bit more complex.
But we can still talk about why one mortgage rate on a certain product is better than another.
In a recent post, I touched on the different mortgage terms available, such as 30-year, 15-year, etc.
That was also a “best of” article, where I attempted to explain what the mortgage term would be Best In any particular situation.
Related to that is the mortgage interest rate that comes with a given loan term. Together, they can drive your mortgage product decision.
Longer loan term = higher mortgage rates
- The longer the fixed rate period, the higher the interest rate
- This compensates the lender (or their investors) for taking on more risk.
- Because they are agreeing to a fixed interest rate for a long period of time
- For example, a 30-year fixed loan will cost more than a 15-year fixed loan.
Now I’m going to assume that by best you mean least, so we’ll focus on that definition, even if it may not be in your best interests. Well, there were a lot of jokes, but I’m trying to ignore them.
Simply put, a longer mortgage term generally translates to a higher mortgage rate.
So a 10-year fixed rate mortgage will be much cheaper than a 40-year fixed loan for two borrowers with similar credit profiles and borrowing needs.
Additionally, an adjustable rate mortgage will generally cost less than a fixed rate loan, because you are guaranteed a stable rate for the entire term of the latter.
It’s all about risk – a mortgage lender is essentially giving you an upfront discount on the ARM in exchange for uncertainty about the future.
With a fixed-rate loan, nothing changes, so you’re paying full price, if not a premium, for peace of mind in the future.
If the interest rate is fixed, shorter-term loans will be cheaper because the lender will not have to worry about where rates will be in 20 or 30 years.
For example, they may offer you a lower mortgage rate on a 10-year term versus a 30-year term because the loan will be paid off over a decade instead of three.
After all, if rates go up and triple in 10 years, they won’t be thrilled with your ultra-low rate that’s locked in for the next 20 years.
It’s all pretty straightforward, but it can be a little more difficult to know which one to choose, and may require clearing out the mortgage calculator.[How to get the best mortgage rate.]
Mortgage interest rates from cheapest to most expensive
- 1-Month ARM (cheapest,
- 6 month arm
- 1-YEAR ARM
- 10 years fixed
- 15 years fixed
- 3-YEAR ARM
- 5-YEAR ARM
- 7-YEAR ARM
- 10-YEAR ARM
- 30 years fixed
- 40-year fixed (most expensive,
This may of course vary from bank to bank. But that’s a rough order of how mortgage rates can be priced from lowest to highest, at least in my view.
Many lenders don’t even offer all of these products, especially super-short-term ARMs. However, you can get an idea of what is the cheapest and most expensive based on its duration and/or its scheduled duration.
According to my own research of the latest mortgage rate data, the very popular 30-year fixed is currently priced at around 7.375%, while the 15-year fixed is priced at 6.50%.
The Hybrid 5/1 ARM, which is fixed for the first five years and adjustable for the remaining 25, can average a slightly lower 6.625% compared to a fixed 30-year ARM.
The cheapest mainstream product is the 10-year fixed, which averages around 5.75% because the term is so short.
There are many other loan programs, such as 20-Year Fixed, 40-Year ARM, 10-Year ARM, 7-Year ARM, etc.
But let’s focus on the 30-year fixed and 5-year ARMs, since they are the most popular in their respective categories.
You pay the premium for a fixed term of 30 years
As you can see, the 30-year fixed is the most expensive in the chart above. In fact, it’s about one percentage point higher than the average rate on a 5/1 ARM.
This spread can and will vary over time, and at the moment it is not very wide for most lenders, which means ARM discounts are not very good.
Other times, it can be a difference of one percent or more, making the ARM much more attractive.
Anyway, at a loan amount of $400,000, there will be a difference of about $200 in monthly mortgage payments and about $12,000 over five years.
For the record, a 3/1 ARM or a one-year ARM would be even cheaper, although probably only slightly. And for a loan that adjusts every three years or annually, that’s a big risk in this rate environment.
As mentioned, the low initial rate on the 5/1 ARM is only guaranteed for five years. It then becomes adjustable annually for the remaining term. This is many years of uncertainty. Actually, this is a 25 year risk.
The fixed limit of 30 years is fine, fixed. So it is not going up or down at any time during the loan period.
There is a possibility that ARM will collapse, but probably not likely. And lenders often impose interest rate floor minimums that limit any potential interest rate improvements. go figure.
What is the cheapest type of mortgage?
- va loancheapest,
- FHA loan
- usda loan
- conforming loan
- jumbo loan (most expensive,
If we’re talking about types of mortgages, you’ll likely find that VA mortgage rates are some of the lowest compared to other loan programs.
This is because VA loans are government-backed loans and they are guaranteed by the VA should the loan default.
In this case, the VA pays the lender, so there is less risk in making the loan. So even with a 0% down payment, VA loans offer the lowest rates in most cases.
For example, the price for a 30-year fixed VA loan is currently around 6.75%, while the price for a conforming loan backed by Fannie Mae or Freddie Mac is closer to 7.50%.
This is a significant difference in rate, which will equate to a lower down payment even if zero is put on the purchase of the home.
The next cheapest type of mortgage is the FHA loan, which is also government backed and comes with mortgage insurance (MIP) that is paid for upfront and monthly by the borrower.
This protects lenders in case of borrower default and results in lower mortgage rates.
FHA mortgage rates tend to be about half a percentage point lower than comparable conforming loans, so if the conforming loan is priced at 7.50% it might be 7%.
Then there are USDA loans, which are also government backed, but can cost a little more than 7.25%.
This leads us to conforming loans, which are priced above all the government-backed loans mentioned.
Additionally, you have jumbo loans, which are typically more expensive than conforming loans. However, it may sometimes flop depending on market conditions.
Also note that the interest rate is just one piece of the pie. There are also closing costs and mortgage insurance premiums that can push the mortgage APR higher.
So when comparing conventional loans versus FHA loans, it is important to consider all the costs.
Combining loan programs with loan types, the 15-year fixed VA loan will technically be the cheapest.
So what is the best mortgage rate?
- The best mortgage rate is the one that saves you the most money
- Once you take into account monthly payments, closing costs and interest expenses
- Also what can your money do if it is invested somewhere else
- And what are your plans with the underlying asset (how long do you intend to hold it, etc.)
Best interest rate? Well, it depends on many factors unique to you and only you.
Are you planning to stay in this property for a long time? Or is it a starter home that you think you’ll outgrow in a few years?
And is there a better place for your money, like the stock market or another high-yield investment?
If you plan on selling your home in the medium or near term, you can go with an ARM and use that monthly savings for a down payment on a subsequent home purchase.
Just make sure you have enough money to make the larger monthly payments. Your ARM adjusts higher if you don’t actually sell or refinance your mortgage before then.
Five-year interest rate stability not enough? Consider the 7/1 and 10/1 ARMs, which don’t adjust until years seven and 10, respectively.
That’s quite a long time, and the discount relative to the 30-year discount may be worth it. Just expect smaller ARMs relative to shorter term ARMs.
But if you don’t like the stress at all and/or can’t take the risk, a fixed-rate mortgage is probably the only way to go.[30-year fixed vs. ARM]
Short-term mortgages like 15-year fixed are the best deal
If you have a lot of money and really want to pay off your mortgage quickly, a 15-year fixed term will be the best deal. And as mentioned, a 10-year fixed could be even cheaper.
The shorter tenure also means that less interest will be paid to the lender. The downside is the high monthly payment, which not every homeowner can afford.
This is especially true now that mortgage rates are much higher than they were two years ago.
One option is to go with a 30-year fixed term and make additional payments every month. This allows it to operate like a fixed term of 15 years with added flexibility.
As a general rule, when interest rates are low, it makes sense to lock in a fixed rate, especially if the ARM discount is not large.
But mortgage rates are no longer cheap.
An ARM can work, just know the risks
Conversely, if interest rates are high, it may be worth taking the initial discount with an ARM.
If when it comes time to refinance (after the initial fixed period is up) rates have dropped, you may do really well.
And even if rates fall soon after you get your mortgage, you can refinance to another ARM, increasing your fixed term.
Or simply trade in your ARM for a fixed rate mortgage if rates get really good during that time.
The other side of the coin is that rates may keep climbing. If your ARM adjusts higher and the interest rates are no longer favorable at the time of refinancing, it could put you in a difficult situation.
Ultimately, you are always taking a risk with ARM. But you can also be leaving money on the table with a fixed-rate loan, especially if you don’t keep it anywhere close to the term.
Either way, keep an eye on those closing costs and be wary of resetting the clock on your mortgage if your ultimate goal is to pay it off in full.
In the end, it may all come down to what you are comfortable with.
For many people, the stress of ARM is not worth any potential discount. So perhaps a certain mortgage is “best” even if they are no longer cheap.
Read more: Which Mortgage is Right For Me?