Fixed vs. adjustable-rate mortgage (ARM): Key differences to know

Our list of the best mortgage lenders is a good place to start as you compare offers to find one that’ll best fit your needs. While fixed-rate mortgages are by far the most common route for American homebuyers, about 8% choose to go with an adjustable-rate mortgage (ARM). 

Both come with their own terms, benefits, and risks—and in this piece, we’ll help you evaluate whether a fixed-rate home loan or an ARM might be better for you.

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How fixed-rate mortgages work

Fixed-rate mortgages are the most popular, and in a lot of ways the last complicated, way to finance a home. When you apply for a mortgage, you’ll agree upon a fixed interest rate for the duration of your loan. This should largely keep your monthly mortgage payment consistent, though elements such as property taxes, homeowners association (HOA) dues, and homeowners insurance can still increase.

You’ll often find fixed-rate mortgages for terms ranging from 10 to 30 years. These loans typically front-load your interest, meaning the majority of your monthly payment won’t go toward your principal debt for many years. For this reason, it’s wise to throw every shiny red penny you can spare toward making extra payments early on. Doing this will lower the interest payment you make in the following months.

Fixed-rate mortgages allow you to lock-in current interest rates for decades to protect you from the potential of increased rates down the road.

Pros and cons of fixed-rate mortgages

How adjustable-rate mortgages work

Adjustable-rate mortgages can often be less expensive initially, but the tradeoff is that they tend to be more risky further down the road.

Here’s why: When you open an ARM, you’ll get a specified window of time—up to 10 years, in some cases—with a fixed interest rate that may well be lower than you could get with a traditional fixed-rate mortgage. But after that, your interest rate will fluctuate based on two lender-specific elements:

1. ARM index. Your lender selects a market index to base your interest rate off of. Examples include the prime rate, the U.S. Treasury bill rate, and the SOFR. As this index increases and decreases, so will the interest rate you’re required to pay.
2. Margin. On top of the index-dictated interest rate, financial institutions can tack on additional interest to your mortgage. This is one of the ways they make money. The margin is established upon account opening and stays the same throughout the term of your loan.

Fortunately, ARMs come with “caps.” This guarantees that your loan shouldn’t make any excessive swings that could cripple your finances. As an example, if your adjustment cap is 2%, your interest rate can’t change by more than 2 percentage points during any given adjustment.

The three caps you should pay attention to are as follows: the initial adjustment cap, the subsequent adjustment cap, and the lifetime adjustment cap. As you might expect from the terminology, the first dictates how much your rate can change the first time it adjusts—the second dictates later adjustments, and the last limits how much it can change in total.

ARMs are named according to their fixed interest period and the frequency of your rate’s adjustment period afterwards. For example:

• A 7/6 ARM means you’ll get a seven-year fixed interest rate followed by the potential for a rate adjustment every six-months.
• A 5/1 ARM means you’ll get a five-year fixed interest rate followed by the potential for a rate adjustment every year.

Let’s say you’ve got a 5/1 ARM with a 2% margin. For the first five years, you’ll get a predetermined interest rate—say, 7%. After that, your interest rate can change once per year (though your 2% margin will remain the same):

• If the market has increased to 7%, you’ll pay 9% in interest that year.
• If the market falls to 4% the following year, you’ll then pay 6%.

If you feel confident in the future of the market, or if you plan on selling your house before the fixed interest rate ends, an ARM may be a solid option for you. You can enjoy the low fixed interest rate without worrying about the volatility that comes after it ends. But if you intend to stay in the home and keep the same loan for many years, the stability of a fixed-rate mortgage may be preferable. 

Pros and cons of ARMs

Differences between fixed-rate mortgages and ARMs

To understand the different ways a fixed-rate mortgage and an ARM might play out in terms of how much you end up paying over time, let’s simulate a similar loan for each.

These hypotheticals will be for a $350,000 home loan over a 30-year term, assuming a 5/1 ARM increases by 0.15% each year after its fixed introductory interest rate.

Year	Fixed-Rate Mortgage (6.5%)	5/1 ARM (5.5% initial rate, +0.15%/yr)
5	$132,734	$119,236
10	$265,469	$243,546
15	$398,203	$375,486
20	$530,937	$513,698
25	$663,671	$656,493
30	$796,406	$801,797

5
Fixed-Rate Mortgage (6.5%)	$132,734
5/1 ARM (5.5% initial rate, +0.15%/yr)	$119,236
10
Fixed-Rate Mortgage (6.5%)	$265,469
5/1 ARM (5.5% initial rate, +0.15%/yr)	$243,546
15
Fixed-Rate Mortgage (6.5%)	$398,203
5/1 ARM (5.5% initial rate, +0.15%/yr)	$375,486
20
Fixed-Rate Mortgage (6.5%)	$530,937
5/1 ARM (5.5% initial rate, +0.15%/yr)	$513,698
25
Fixed-Rate Mortgage (6.5%)	$663,671
5/1 ARM (5.5% initial rate, +0.15%/yr)	$656,493
30
Fixed-Rate Mortgage (6.5%)	$796,406
5/1 ARM (5.5% initial rate, +0.15%/yr)	$801,797

But, to state the obvious, there’s no guarantee your specific ARM will behave the same as the example we’ve crafted, or that your specific fixed-rate loan will follow the example amortization. 

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Is a fixed-rate mortgage or ARM better?

Neither a fixed-rate mortgage or an adjustable-rate mortgage is intrinsically “better.” It all depends on your goals. That said, roughly 92% of homebuyers opt for a fixed-rate loan, so it’s clearly the more popular choice.

Who is a fixed-rate mortgage for?

A fixed-rate mortgage suits those who want a more straightforward and predictable mortgage. You don’t have to worry about fluctuating interest rates or monthly payments due to a fickle market; you may pay slightly more in interest for the luxury, but you’ll know almost exactly what to expect.

Who is an adjustable-rate mortgage for?

An ARM is a popular choice among those who plan to exit the loan in some way before the introductory fixed interest period ends. Think selling or refinancing the home. Lower initial interest rates mean you’ll likely pay less out of pocket than a fixed-rate mortgage, at least at first.

These are higher-risk-higher-reward loans that can potentially save you a significant chunk of money during the first few years of holding the mortgage. For example, an ARM may be a strong option if you’re looking to finance an investment property that you’ll flip or rent out. But you need to have a level of comfort with uncertainty to take out an ARM.

The takeaway

Fixed-rate mortgages and adjustable-rate mortgages cater to prospective homebuyers with different goals and comfort levels. For those who want the path of least resistance at the cost of a potentially higher interest rate, a fixed-rate mortgage more clearly aligned with that. 

But, for buyers who think they’ll sell or refinance within a few years, and are willing to accept a little unpredictability in exchange for a favorable intro rate, applying for an ARM could be a smart move.