Fixed vs Adjustable-Rate Mortgage: Which One Fits You?
The choice between a fixed-rate and an adjustable-rate mortgage comes down to one question: how much rate risk you are willing to carry in exchange for a lower starting payment. The right answer depends far more on how long you will keep the loan than on predictions about interest rates.
Key takeaways
- A fixed-rate mortgage keeps the same principal-and-interest payment for the whole term.
- An ARM starts with a lower rate for a set period (often 5, 7 or 10 years), then moves with a market index within limits called caps.
- On a $400,000 loan, a 6.00% ARM versus a 6.75% fixed saves about $196 a month, or $11,800 over five years.
- If that ARM resets to 8% after five years, the payment rises to about $2,873. At an 11% lifetime cap it would be about $3,648.
How a fixed-rate mortgage works
With a fixed rate, the interest rate is set on day one and never changes. The principal-and-interest payment stays identical for 15, 20 or 30 years, which makes budgeting simple. If market rates fall later, you can usually refinance to capture the lower rate. If they rise, you keep your rate. You pay for that protection through a starting rate that is usually higher than an ARM’s.
Property taxes and insurance collected in an escrow account can still change, so the total monthly bill can move even on a fixed-rate loan.
How an adjustable-rate mortgage works
An ARM has two phases. During the initial fixed period the rate behaves like a fixed mortgage. After that, the rate resets periodically to an index plus a margin. In the US most new ARMs use SOFR (the Secured Overnight Financing Rate) as the index. The margin is a fixed number of percentage points set in your contract.
Three caps limit how far the rate can move:
- Initial adjustment cap: the most the rate can change at the first reset.
- Periodic cap: the most it can change at each later reset.
- Lifetime cap: the most it can ever rise above the starting rate.
A 5/6 ARM with 2/1/5 caps, for example, is fixed for five years, can rise by up to 2 points at the first reset, up to 1 point every six months after that, and never more than 5 points above the starting rate.
A worked comparison
Suppose you borrow $400,000 over 30 years and are offered 6.75% fixed or a 5/6 ARM starting at 6.00%. These are illustrative rates; check current averages before comparing real offers.
| Scenario | Monthly payment |
|---|---|
| 30-year fixed at 6.75% | $2,594.39 for 30 years |
| 5/6 ARM at 6.00%, years 1–5 | $2,398.20 |
| ARM resets to 8.00% after year 5 (balance about $372,200) | $2,872.83 |
| ARM reaches its 11.00% lifetime cap | $3,648.15 |
The ARM saves about $196 a month, roughly $11,800 over the first five years. If you sell or refinance before the reset, that saving is real and the risk never materialises. If you keep the loan and rates are higher at the reset, the saving can be wiped out within a few years, and in the worst case the payment rises by more than $1,000 a month compared with the fixed loan.
Run the fixed payment and the ARM payment at the reset rate you think is plausible, then at the lifetime cap, and check whether your budget survives the higher figure.
Questions that decide it for most people
1. How long will you keep this loan?
This is the most important factor. If you expect to move, sell or refinance within the initial fixed period, an ARM’s lower rate is mostly upside. If you expect to stay ten years or more, you will spend most of the loan’s life in the adjustable phase, and a fixed rate removes that uncertainty.
2. Could you afford the capped payment?
Calculate the payment at the lifetime cap, not just at the first reset. If that number would force you to sell, the ARM is riskier than it looks. Lenders often qualify ARM borrowers at a higher rate for this reason. Your debt-to-income ratio at the capped payment is a useful test.
3. Is the saving large enough to matter?
When the gap between fixed and ARM rates is small, say a quarter of a point, the ARM saves little while still carrying the reset risk. The case for an ARM is strongest when the gap is wide and your time horizon is short.
4. Can you count on refinancing?
“I’ll just refinance before it adjusts” assumes your income, credit and home value will all still qualify you, and that fixed rates will be acceptable then. Treat refinancing as an option, not a plan.
The UK version of the same decision
In the UK, almost all mortgages are fixed for a short period, typically two or five years, then revert to the lender’s standard variable rate unless you remortgage. The decision is similar: a two-year fix may be cheaper today but exposes you to rates sooner, while a five-year fix gives longer certainty. Early repayment charges usually apply if you leave a fixed deal early, so match the fix length to how long you are likely to stay.
Bottom line
Choose a fixed rate if you value a payment that never changes, plan to stay a long time, or could not comfortably absorb the capped ARM payment. Consider an ARM if you have a clear, realistic plan to sell or refinance within the fixed period and the rate saving is meaningful. Whatever you choose, look at the total cost under a pessimistic scenario, not only the first-year payment. Our guide to mortgage amortization shows how the balance falls in those first years.
Frequently asked questions
What does 5/6 ARM mean?
The first number is how many years the starting rate is fixed (5). The second describes how often it adjusts after that; a 5/6 ARM adjusts every 6 months once the fixed period ends.
What are ARM rate caps?
Caps limit how far the rate can move: the first adjustment cap, the cap on each later adjustment, and a lifetime cap above the starting rate. Caps of 2/1/5 are common on 5/6 ARMs.
Can I refinance out of an ARM before it adjusts?
Often, yes, but it is not guaranteed. You need to qualify again, pay closing costs, and accept whatever fixed rates are available at that time.
Is a UK tracker or variable mortgage the same as a US ARM?
They are similar in spirit. Most UK mortgages are fixed for 2 to 5 years and then move to the lender’s variable rate unless you remortgage, so the same “how long will I keep this deal” question applies.
Sources
- Consumer Financial Protection Bureau: Consumer Handbook on Adjustable-Rate Mortgages (PDF)
- Freddie Mac: Primary Mortgage Market Survey (weekly average rates)
- MoneyHelper (UK): Understanding mortgages and interest rates
This guide is general information to help you understand the numbers. It is not financial, tax or legal advice. Rates, limits and rules change, so check official sources or a qualified adviser before making a decision. Read our full disclaimer.