Fixed vs Adjustable-Rate Mortgages: Which Should You Choose?
A fixed-rate mortgage keeps the same rate for the whole loan, while an adjustable-rate mortgage (ARM) starts with a fixed rate for a few years and then changes. Here's how ARMs work, what the caps mean, a worked example and when each one makes sense.
By Pond.com editors Updated 3 min read
Quick answer
- A fixed-rate mortgage has the same interest rate, and the same principal and interest payment, for the whole loan.
- An ARM has a fixed rate for an initial period, often 5, 7 or 10 years, then adjusts, often every six months.
- ARMs usually start with a lower rate, but your payment can rise sharply later.
- Caps limit how much the rate can rise at each change and over the life of the loan.
- An ARM can make sense if you're confident you'll sell or refinance before it adjusts.
Choosing between a fixed and an adjustable rate is one of the biggest decisions in getting a mortgage. A lower starting rate can be tempting, but it comes with the risk that your payment rises later.
This article is general information, not financial advice.
How each one works
- Fixed-rate: the rate never changes. Your principal and interest payment stays the same for 15 or 30 years. Taxes and insurance can still change.
- Adjustable-rate (ARM): the rate is fixed for an initial period, then changes based on a market index plus a set margin. The most common today are 5/6, 7/6 and 10/6 ARMs, which are fixed for 5, 7 or 10 years and then adjust every 6 months.
Rate caps
ARMs have caps that limit how far the rate can rise. They're often written as three numbers, such as 2/1/5:
| Cap | Example | What it limits |
|---|---|---|
| Initial | 2 | How much the rate can rise at the first adjustment |
| Periodic | 1 | How much it can rise at each later adjustment |
| Lifetime | 5 | How much it can rise over the whole loan |
Ask every lender for the caps, the index, the margin and the highest payment you could ever have.
A worked example
Say you borrow $360,000 on a 5/6 ARM starting at 6.5%, with 2/1/5 caps:
- First five years: about $2,275 a month in principal and interest. A 30-year fixed loan at 7.32% would be about $2,473, so you'd save about $200 a month.
- First adjustment: if rates have risen, the rate could jump to 8.5%. On the remaining balance of about $337,000, the payment would rise to about $2,714.
- Worst case: at the 11.5% lifetime cap, about $3,425 a month.
If rates fall instead, your payment could go down, but usually not below a floor set in the loan.
When each one makes sense
| A fixed rate suits you if | An ARM may suit you if |
|---|---|
| You plan to stay for many years | You're confident you'll move before the rate adjusts |
| You want a predictable payment | You expect your income to rise and could afford the worst-case payment |
| Rates are fairly low now | You'd use the savings to pay down the loan faster |
| A payment rise would strain your budget | You understand and accept the risk |
Questions to ask before choosing an ARM
- What's the highest my payment could be, and could I afford it?
- What happens if I can't sell or refinance when the fixed period ends?
- Is there a prepayment penalty if I refinance early?
- How much am I really saving each month, and is it worth the risk?
Common questions
The rate is fixed for the first 5 years, then adjusts every 6 months for the rest of the loan. A 7/6 ARM is fixed for 7 years and a 10/6 ARM for 10 years. Older ARMs often adjusted once a year, written as 5/1.
Usually, yes, as long as you qualify at the time. But that depends on your credit, income, home value and the rates on offer then, none of which you can be sure of in advance, so don't count on it.
It's the market rate your new rate follows when the loan adjusts. Most new ARMs use SOFR, a widely used benchmark for short-term interest rates. Your rate is the index plus a fixed margin set in your loan, within the caps.