Should You Get a Fixed Rate or Adjustable Rate Mortgage? What to Know Before Deciding

For many people, learning the ins and outs of mortgages is the least interesting part of the home-buying process. While you may want to speed through closing once you’ve found your dream house, you'll be making monthly mortgage payments on that home for many years to come. That's why it's important to understand different mortgage types.

One important distinction is the difference between a fixed-rate and an adjustable-rate mortgage. As the names suggest, fixed-rate mortgages will have consistent mortgage rates throughout the entire loan term as opposed to adjustable-rate mortgage loans, which can have multiple rate adjustments throughout the years.

While every housing purchase is unique, fixed-rate mortgages are generally preferable if you're looking to settle into a home permanently, while adjustable-rate mortgages could be a good choice if you're planning to sell the home before the initial interest rates adjust.

How Do Fixed Rate Mortgages Work?

A fixed-rate mortgage is a home loan with an annual percentage rate or APR that will not change. The APR represents the yearly cost of the loan, including interest and fees.

For example, a 15-year fixed-rate mortgage will feature consistent, amortizing payments every month for 15 years. Amortization means that each loan payment applies toward the principal balance as well as the interest. In other words, as long as you make your payments on time and in full, the loan will be completely settled by the end of the mortgage term.

Thirty-year fixed-rate mortgages also have consistent payments and a fixed interest rate, but as the name suggests, feature a longer amortization schedule. Translation: You'll have lower monthly payments, but will pay more in overall interest across the life of the loan.

If you're confident in your ability to make larger monthly payments, it may make sense to choose a shorter loan term, though ultimately it will come down to your personal finance situation.

You can use a mortgage calculator and speak to your mortgage loan officer to help determine which loan option would be best for you.

How Do Adjustable Rate Mortgages Work?

Unlike a fixed-rate mortgage, the loan rates for adjustable-rate mortgages – also referred to as ARMS – change periodically. The most common types of ARMs are called hybrid ARMs because they contain both fixed and adjustable mortgage rate components. The initial mortgage rate will be fixed for a certain number of years and then adjust upward or downward (though usually upward) at regular intervals.

How Often Do Arm Loan Rates Adjust?

ARM terms are expressed as X/Y, where X is the initial fixed-rate period in years and Y is generally the period of time between adjustments after the initial period has passed.

For example, a 5/3 ARM will have a consistent mortgage interest rate for five years, after which the variable rate will kick in. That variable rate will then adjust every three years.

Be aware that the second number in ARM measurements may not always represent a number of years. It could represent a number of months, or in some cases, it could represent the number of years the mortgage will have a variable rate rather than the amount of time in between rate resets. Be sure to clarify exactly what the ARM terms represent when speaking with your mortgage loan officer.

How Are ARM Rates Determined?

After an ARM’s fixed period has passed, interest rate changes will be calculated according to an index specified by your lender.

An index is a benchmark rate tied to a specific market value like the Federal Reserve’s prime rate or the Secured Overnight Financing Rate (SOFR), which is a measure of how much banks need to pay to borrow against the value of U.S. Treasury securities. SOFR replaced the London Interbank Offered Rate (LIBOR), which was discontinued in 2023.

The lender also specifies a “margin amount” in the mortgage contract. This margin amount will be added to the index number to determine your new actual rate during adjustment periods.

Different mortgage lenders may use different index rates and margins, but the chosen index and margin amount should be made clear in your mortgage agreement. Consider shopping around for different mortgage options and consulting a financial advisor to be sure you're aiming for the lowest rate possible.

Are There Limits To ARM Rate Hikes?

There are a few common types of rate caps that limit the increases ARM providers can implement during adjustment periods:

Initial adjustment cap

The initial adjustment cap limits the amount a lender can increase the interest once the introductory rate period expires. These caps could help you avoid balloon payments, which are sudden large payments that can surprise mortgage borrowers after years of consistency.

Subsequent adjustment cap

Subsequent adjustment caps control the rate increase during each adjustment period.

Lifetime adjustment cap

The lifetime cap limits the maximum interest rate an ARM loan program can ultimately reach.

While the specifics of these caps may not seem particularly important if you're certain you'll be selling the property before the introductory period expires, you never know what can happen. The value of the home could go down or market conditions could change that impact your ability to sell the property.

That's why it's important to establish the best caps you can before signing on the dotted line; by doing so, you won't risk committing to ARM interest rates far outside what you can afford.

Can An Adjustable Rate Mortgage Save You Money?

It’s possible for an ARM to save you money, assuming you’re not planning to hold on to the house for too long.

Let’s look at a hypothetical scenario with a $300,000 loan amount to understand why.

Since ARMs tend to start with a low rate in the short term, let’s compare a 30-year fixed-rate mortgage with a 4% interest rate to a 7/1 ARM with a starting interest rate of 3.5%. Now let’s assume you’re going to resell the house in seven years.

That half a percent difference between the fixed-rate and the adjustable-rate loan represents $1,500 in one year, a gap that will grow over the next seven years as the interest continues to accumulate and compound. It’s entirely possible to save thousands of dollars by choosing an ARM in that situation.

That only applies, of course, if you sell the home before the adjustment period begins. If you’re worried you’ll miss the deadline, you can try to refinance to a fixed-rate mortgage before that happens.

Why Do ARMs Offer A Lower Interest Rate At First?

The reason lenders are willing to offer lower initial rates for ARMs is because they do not have to factor in the risk of locking in one rate for 15 or 30 years. Lenders can originate a loan below the market rates now in exchange for the ability to raise rates in the future.

What Else Is Included In The Monthly Payment Obligation?

Regardless of your loan type, it's important to remember that your monthly payments include more than just the principal balance and interest amount.

Many mortgage products will include additional costs like property taxes and private mortgage insurance as part of the monthly payments.

The listed annual percentage rate should include these costs as well as any other extra payments, like origination fees, but you should go over the entirety of the agreement with your mortgage loan officer just to be sure.

Should I Get A Fixed Rate Or Adjustable Rate Mortgage?

Ultimately, choosing between a fixed- and adjustable-rate mortgage will depend on your personal situation, the property you're planning to purchase, what you're planning to do with the property, and how long you're planning to hold on to the property before attempting to sell it.

As we’ve established, an adjustable-rate loan with a competitive rate can be a good mortgage loan option if you're looking to flip an investment property and plan to sell before the initial fixed-rate period ends.

Fixed-rate loans, on the other hand, are a more appropriate type of mortgage if you're planning to live in the home long-term, so you can rely on predictable payments based on current mortgage rates for many years to come.

No matter which option you pick, it's always possible that your personal circumstances, or the real estate market as a whole, can change. If a mortgage that had seemed like a good idea is no longer working for you, inquire about your refinancing options.

Within the ARM and fixed-rate mortgage categories there are also more loan types to learn about. For example, FHA loans, which are loans that are backed by the government, come in both fixed-rate and adjustable-rate varieties and can be a good potential option for first-time homebuyers.

It’s also possible that now just isn’t the right time to enter the world of homeownership. If the numbers aren’t adding up, consider waiting until you can afford a larger down payment or your credit score improves.

The Bottom Line

Learning about ARM loan rates and fixed-rate periods may not be the most exciting part of the home buying process, but this is one of the biggest commitments you'll make in your life. You want to be sure you find the best financial product for your upcoming life as a homeowner.