Fixed-Rate vs. Adjustable-Rate Mortgages: Which Is Better?

Your mortgage interest rate is important to know because it affects how much you pay each month — and in total ⁠— for your home. A key factor that will help determine your interest rate is whether you choose a fixed-rate mortgage or an adjustable-rate mortgage.

The Difference Between Fixed and Adjustable-Rate Mortgages

In the simplest terms, a fixed-rate mortgage means the interest rate on your home loan never changes. The interest rate on an adjustable-rate mortgage, on the other hand, can fluctuate throughout the loan term depending on market conditions.

With an ARM, the initial rate may be lower compared to a fixed-rate mortgage, but it will likely increase. Fixed-rate mortgages offer more certainty, but tend to have higher rates initially.

Other areas where fixed-rate mortgages and ARMs differ are the monthly payment and amortization schedule. The amortization schedule refers to a table that lays out how much you’ll pay each month for your mortgage, plus how much of each payment is going toward the loan principal versus interest. 

Here’s a breakdown of those key differences between the two interest rate types:

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What Is a Fixed-Rate Mortgage?

A fixed-rate mortgage is a home loan where the interest rate doesn’t change throughout the life of the loan. You know from the start how much you’ll need to pay each month, and how much of each payment goes toward paying interest versus paying down the principal.

This interest rate type offers stability and predictability. While your payments could still go up or down if the cost of homeowners insurance or property taxes change, you don’t have to worry about rate hikes causing your monthly payment to jump.

Fixed-rate mortgages are popular with homeowners. Historically, 70% to 75% of homebuyers have chosen a fixed-rate mortgage, according to the Consumer Financial Protection Bureau. Today, 90% of homebuyers choose a 30-year fixed-rate mortgage, according to Freddie Mac.

How does a fixed-rate mortgage work?

When you start making payments on a fixed-rate mortgage, most of it will go toward paying interest. Over time, more of the payment amount will be allocated to paying off the principal. Your payments will generally stay the same each month, despite the varying distributions between interest and principal.

Fixed-rate mortgages often come with higher interest rates than ARMs — but only in the beginning. After an introductory period, the interest rate on an ARM may change, while the rate on a fixed-rate mortgage will remain steady.

One way your interest rate on a fixed-rate mortgage could change is if you refinance, in which case your rate will reset based on current market conditions and other factors.

Fixed-rate mortgage pros and cons

A fixed-rate mortgage comes with both benefits and drawbacks.

Fixed-rate mortgage advantages

• Your monthly payment is predictable, which means you can plan more accurately for the future.
• The interest rate on your mortgage stays the same, so the total cost for the loan is set.
• You take on less overall risk with a fixed-rate mortgage.

Fixed-rate mortgage disadvantages

• You’re usually charged a higher interest rate compared with the rates offered during the introductory period of an ARM.
• If you take out a mortgage while interest rates are high, then you’ll be locked into that rate.

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What Is an Adjustable-Rate Mortgage?

An adjustable-rate mortgage is a home loan where the interest rate can vary, or adjust, throughout the loan term. The rate on an ARM is typically fixed for a certain number of years at the beginning, but it can increase after that initial period.

The interest rate on an ARM changes based on market conditions, which means your monthly payment and the total interest charged will fluctuate. For this reason, ARMs are considered a riskier choice. While some ARMs limit how high or low your interest rate may go, you can’t fully predict how and when the rate will change.

ARMs marketed to homebuyers who have lower credit scores tend to come with higher interest rates, rates that adjust more often, prepayment penalties, and other riskier features. So, be sure to read the fine print before agreeing to take on this type of mortgage.

ARM terminology

Before you learn how an adjustable-rate mortgage works, get to know these common ARM terms:

• Initial rate: The interest rate that your loan starts with.
• Payment: The amount you must pay each month for your mortgage.
• Adjustment period: How frequently the interest rate and payment can change. For example, an adjustment period of one year means that the rate may change annually.
• Index: A measure of wider interest rates that reflects market conditions. The rate on an ARM is partly based on an index, and adjusts up or down accordingly.
• Margin: A number of percentage points added to the index that generally remains constant throughout the loan term. Combined, the index and margin determine the interest rate on your ARM.
• Interest rate cap: A limit on how much the interest rate on your ARM can increase between adjustment periods or over the loan’s lifetime.
• Payment cap: A limit on how much your payment can increase with each adjustment.
• Hybrid ARM: A type of ARM that has a fixed interest rate for the first few years of the mortgage.
• Interest-only ARM: A type of ARM where you only need to pay interest each month for a number of years. After that, you must start repaying the principal as well, which means your payment will increase.

How does an ARM work?

The interest rate on an ARM typically starts off lower compared with a fixed-rate mortgage, and remains the same for several years. How long the initial rate lasts may range from six months to 10 years, but usually spans three, five, or 10 years.

Once the initial fixed-rate period is over, your interest rate will adjust and likely increase, which means your payment will become more expensive. Some ARMs don’t offer an initial fixed-rate period, so make sure to find out how soon your monthly payment could change.

Using an example, a 5/1 ARM indicates that the initial rate will last five years, and the rate will adjust once every year after that until the mortgage is paid off. Most ARMs come with a 30-year loan term, and the most common adjustment period is one year.

As of Oct. 13, 2022, the average interest rate on a 5/1 ARM is 5.81%, according to Freddie Mac. For comparison, the average rate one year prior was 2.55%, and it was 2.90% during the same period in 2020 — demonstrating that your initial rate could change significantly.

What causes your rate to adjust?

Your mortgage interest rate is composed of the index and the margin. If the index changes after the initial fixed-rate period, then your interest rate and monthly payment will change as well. Different lenders will vary in which index they use.

Adjustable-rate mortgage pros and cons

Here’s a breakdown of the benefits and drawbacks to choosing an ARM.

ARM advantages

• You may start off with a lower interest rate compared with fixed-rate mortgages.
• Depending on the market, your interest rate and monthly payment could decrease down the line.
• An ARM can be cheaper in the short term, especially if you plan to move again soon.

ARM disadvantages

• Less predictability makes it more difficult to plan for your other financial goals. 
• Your interest rate and monthly payment may increase significantly. In fact, depending on the terms of your mortgage, your rate could grow by as much as 5 percentage points compared with your initial rate.
• If the rate on your ARM increases, you risk not being able to afford the higher monthly payments — and potentially losing your home to foreclosure.

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Fixed or Adjustable-Rate Mortgage: Which Is Right for You?

There are many factors that can help determine what type of interest rate is best for you — including your financial situation, the initial rate, and how long you plan to say in the home.

“A fixed-rate mortgage is best for long-term stability,” says Tabitha Mazzara, director of operations at Mortgage Bank of California in Manhattan Beach, California. “Your monthly payment and interest rate stay the same, and they make budgeting easier.”

While ARMs can offer short-term savings, Mazzara warns of potential trouble down the line.

“ARM is not the best choice if you’re buying your ‘forever home’ because your rate might go up and strain your budget,” she says. “But it might make sense if the purchase is not for the long haul.”

If you change your mind after choosing a fixed-rate mortgage or an ARM, you can decide to refinance your mortgage. However, you’ll need to qualify for refinancing, and the process will come with refinance closing costs, so weigh your decision carefully.

When would it be better to use a fixed-rate mortgage?

Fixed-rate mortgages may appeal to borrowers who want to play it safe and are satisfied with their interest rate. If the following statements apply, then a fixed-rate mortgage could be the right fit:

• You want predictable payments and a lower-risk mortgage. Borrowers with a fixed-rate mortgage won’t face increases in their interest rate, and will have a clear sense of the full cost of their loan.
• You’re planning to stay put. If you’re buying a home for the long haul, then a fixed-rate mortgage is more suitable than an ARM. It provides greater stability, which is better for planning.
• Interest rates are low. A fixed-rate mortgage could help you lock in a favorable interest rate. The Consumer Financial Protection Bureau offers a tool to help you explore typical interest rates in your area.

When would it be better to use an adjustable-rate mortgage?

An ARM may fit your situation if the following statements apply:

• You aren’t planning to live in the same place for long. If you’re going to sell the home before the initial rate adjusts, you could save money with an ARM. However, there’s no guarantee you’ll be able to sell or refinance before the initial fixed-rate period ends. Also, if your financial situation has changed or your home’s value has dropped, you might not qualify for a refinance.
• Interest rates are high. With an ARM, your interest rate generally starts off lower compared with a fixed-rate mortgage, and could decrease if market rates trend downward. Just be sure you can comfortably afford higher monthly payments if the rate on your ARM increases instead.
• You want to buy in a hot housing market. ARMs can grow more popular among homebuyers in response to high home prices.

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FAQ: Fixed-Rate vs. Adjustable-Rate Mortgage

Understanding how fixed-rate mortgages and ARMs work can help you choose the right loan for your needs.

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The Bottom Line on Fixed-Rate Mortgages vs. ARMs 

The biggest overall difference when you’re choosing between variable vs. fixed-rate mortgages is how much risk you’re willing to take on. Fixed-rate mortgages are safer, offering the full picture of how much your mortgage is going to cost. ARMs can help you snag a lower interest rate in the beginning, but you may end up with higher monthly payments and a greater total cost down the road. Before you make a final decision, be sure to weigh the benefits and drawbacks of each interest type.