Fixed-Rate vs. Adjustable-Rate Mortgages: How to Choose
Fixed-rate mortgages are the default choice for good reason — predictability. But adjustable-rate mortgages can save money in specific situations. Here is how to evaluate the trade-off.
How Fixed Rates Work
Your interest rate and principal/interest payment stay the same for the entire loan term (15, 20, or 30 years). Your total payment can still change due to property tax or insurance increases, but the mortgage portion is locked. This is straightforward, predictable, and low-risk.
How ARMs Work
A 5/1 ARM (adjustable-rate mortgage) (the most common) has a fixed rate for the first 5 years, then adjusts annually based on a market index. A 7/1 ARM is fixed for 7 years. The initial rate is typically 0.5-1.5% lower than a comparable fixed rate. After the fixed period, the rate can increase (or decrease) within caps — typically 2% per adjustment and 5% over the life of the loan.
When an ARM Makes Sense
You are confident you will sell or refinance within the fixed period. You expect your income to increase significantly. You are buying in a high-rate environment and plan to refinance when rates drop. The key: you need an exit strategy before the rate adjusts. If you might stay in the home beyond the fixed period, a fixed rate is usually safer.
Key Takeaways
- ✓Fixed rates are predictable — your mortgage payment never changes
- ✓ARMs offer lower initial rates but adjust after the fixed period ends
- ✓ARMs make sense if you are certain you will sell or refinance before the adjustment
- ✓Without a clear exit strategy, a fixed rate is the safer choice
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