When to choose a fixed-rate mortgage vs. an adjustable-rate mortgage (ARM)

When shopping for a home loan, you’re likely to encounter two interest rate structures — fixed-rate and adjustable-rate mortgages (ARMs). Understanding the similarities, differences, benefits and drawbacks between these two different types of mortgages can help you choose the best option for your needs and financial goals.  

Here’s what to know about ARMs vs. fixed-rate mortgages, how they differ and how to decide which might be right for you.

What is a fixed-rate mortgage?

A fixed-rate mortgage has an interest rate that won’t increase or decrease over time. Instead, it remains the same for the life of the loan. These loans typically come with 15- or 30-year repayment terms — though you might also see fixed-rate mortgages with 20- or 40-year terms, depending on the lender you choose. 

No matter the repayment term, the interest rates on fixed-rate loans are often slightly higher than what you’d get with an ARM. 

How a fixed-rate mortgage works

With a fixed-rate loan, you’ll make regular monthly payments to your mortgage lender. These payments — including both principal and interest charges — will remain consistent throughout the life of the loan since the rate won’t ever change. 

Keep in mind that your total monthly costs could still fluctuate slightly if there are changes in your property taxes or home insurance rates. However, this impact will likely be fairly minimal.

What is an ARM?

In contrast to a fixed-rate loan, your rate changes over time with an ARM. This type of mortgage typically comes with a fixed rate for a set period — such as five or seven years. After this fixed-rate period, the rate will then increase or decrease at set intervals, often once every six months or annually. 

It’s common to see 5/1, 7/1, 10/1 and 5/6 ARMs, with the first number representing the fixed interest period for the loan and the second number representing how often your rate will change. For instance, a 5/1 loan means you’ll have a fixed rate for five years, after which it will be adjusted annually. 

The fixed-rate period and interval at which your rate adjusts will vary depending on your mortgage lender. Additionally, most ARMs have 30-year repayment terms, with other repayment terms being uncommon.

Keep in mind: Both fixed- and adjustable-rate options are available for conventional loans as well as mortgages backed by the Federal Housing Administration (FHA) or Department of Veterans Affairs (VA). 

Loans guaranteed by the U.S. Department of Agriculture (USDA) only come with fixed rates, however.

How an ARM works

You’ll also make regular monthly payments with an ARM. However, while your principal payments will remain the same, your interest costs can fluctuate over time once the fixed-interest portion of the loan elapses. 

Your variable rate will be based on an index rate that your lender references. For example, this could be the Secured Overnight Financing Rate (SOFR) or the prime rate, which is impacted by current market conditions. Your lender will also add a margin rate of a few percentage points to the index rate. The margin is set by your lender’s underwriting team and is generally around 2.75%. 

Note that the margin rate on your loan will depend on your credit score at the time your loan is issued. Borrowers with excellent credit typically receive lower margin rates than borrowers with poor credit. Additionally, while the margin rate won’t change over your loan term, it will impact your total loan rate. 

For instance, if you opt for a 5/6 ARM with a 2% margin rate, your lender would add that margin rate to the index rate it references. So, if its preferred index rate is at 5%, and your margin rate is 2%, your total loan rate would be 7% after the initial fixed period. 

Keep in mind: Rate caps also typically apply with ARMs, though these can vary by lender. These caps limit the amount your interest can increase both after the initial fixed period ends and over the life of the loan.

Key differences between fixed- and adjustable-rate mortgages

• Rate structure: The primary difference between fixed- and adjustable-rate mortgages is their rate structure. With a fixed-rate loan, the interest rate remains the same for the life of the loan, while the interest rate with an ARM fluctuates after the initial fixed-rate period. 
• Initial interest rate: If you opt for an ARM, your initial interest rate might be lower than what you’d get with a fixed-rate mortgage. However, this could change once the rate begins to adjust.
• Stability of monthly payments: Because your interest rate can fluctuate with an ARM, your monthly payment amounts can also change. With a fixed-rate mortgage, the payment stays the same for the life of the loan, which can provide more stability for your budget.
• Rate caps: ARMs typically have rate caps, which restrict how much your lender can increase your interest rate over time. However, these only apply to loans with variable interest rates, not to fixed-interest mortgages.

Key similarities

• Monthly installment payments: You’ll need to make monthly payments whether you opt for a fixed- or adjustable-rate loan — the payment structure is the same with both mortgage types.
• Qualification criteria: For the most part, the qualification criteria are similar for getting a mortgage with either a fixed or adjustable rate. Lenders typically require good or excellent credit, sufficient income and a reasonable debt-to-income (DTI) ratio, no matter which interest type you choose.
• Repayment terms: Both fixed-rate and adjustable-rate loans often come with 30-year repayment terms, though you might see 15-year fixed-rate options as well. 

Special programs and assistance options: What to know about first-time homebuyer loans

Which rate should you choose?

Ultimately, the better rate structure for you depends on your situation and your risk tolerance. 

“An ARM can be appealing if you plan to stay in your home for a shorter period,” says Alexander Suslov, head of capital markets at A&D Mortgage. “This choice can potentially offer lower initial rates, providing short-term cost savings.

However, if you’re in it for the long haul and desire predictability in your payments, a fixed-rate loan might be the better fit, safeguarding against potential interest rate fluctuations over time.”