When buying a home or refinancing, one of the most crucial decisions is choosing your mortgage. Fixed-rate and adjustable-rate mortgages have some unique features that can help inform your decision.
Comparison chart
 | Adjustable Rate Mortgage | Fixed Rate Mortgage |
|---|---|---|
| Interest rate | Fixed for an initial period (e.g., 3, 5, 7, or 10 years), then adjusts periodically for the rest of the term. | Fixed for the entire loan term (e.g., 15 or 30 years); never changes. |
| How rate is determined | After the intro period, rate = a benchmark index (e.g., SOFR) + a fixed margin set by the lender. | Set once at origination based on market rates and borrower profile; unchanged thereafter. |
| Initial interest rate | Usually lower than a fixed loan (a "teaser" rate) during the introductory period. | Higher than an ARM's intro rate, reflecting the premium for long-term rate certainty. |
| Interest rate risk | Borne by the borrower. Payments can rise if market rates rise; the borrower benefits if rates fall. | Borne by the lender, who charges a premium for it. The borrower's rate is insulated from market moves. |
| Rate caps | Capped on the first adjustment (initial cap), each later adjustment (periodic cap), and over the loan's life (lifetime cap). | Not applicable; the rate never changes. |
| Affordability (monthly payment) | Lower during the intro period, but can increase substantially after adjustments begin. | Higher but constant and predictable for the life of the loan. |
| Payment predictability | Uncertain after the intro period; subject to payment shock when the rate resets. | Fully predictable; the principal-and-interest payment stays the same throughout. |
| Total interest over loan life | Unpredictable - lower than a fixed loan if rates stay flat or fall, higher if they rise. | Knowable and locked in from day one; total interest never changes. |
| Qualifying / borrowing power | Lenders must qualify the borrower at the highest rate possible in the first five years (ATR/QM rules), which can reduce the amount they can borrow. | Borrower is qualified at the fixed note rate that applies for the whole loan. |
| Refinancing / prepayment | Borrowers often plan to refinance into a fixed loan or sell before the rate adjusts. Prepayment penalties are rare on today's conforming loans. | Refinancing is optional - usually done when market rates fall enough to offset new closing costs. |
| Common terms / types | Hybrid ARMs such as 5/1, 7/1, 10/1 (intro years / adjustment frequency); also 5/6 ARMs that adjust every six months. | Typically 30-year and 15-year; also 10-, 20-, and 25-year terms. |
| Best suited for | Borrowers planning to sell or refinance before the rate adjusts, or expecting rising income or falling rates. | Borrowers who plan to stay long term and want stable, predictable payments. |
| Complexity | More complex; requires understanding the index, margin, caps, and adjustment schedule. | Simple and straightforward to understand. |
Key differences between fixed rate loans and ARM
Interest Rate
In a fixed rate mortgage, the interest rate the bank charges the borrower remains the same throughout the entire duration of the loan (usually 15 to 30 years).
On the other hand, the interest rate on an adjustable-rate mortgage (ARM) is reset periodically (usually ever 6 months) after an initial fixed period of 3, 5, 7 or 10 years. A 3/1 ARM means that the interest rate on the loan is fixed for the first 3 years but changes once a year after that until the loan is repaid; a 5/6 ARM has an interest rate that is fixed for 5 years and then adjusts every 6 months.
Lenders aren't allowed to raise interest rates on an ARM arbitrarily. When the rate is reset, it is determined using a benchmark market rate (usually Secured Overnight Financing Rate (SOFR), which replaced LIBOR in 2023), plus a fixed margin set by the lender when the loan originates.
With a long-term fixed-rate mortgage, the lender assumes the interest rate risk i.e. the risk that interest rates will rise in the future. Therefore,
- Longer term fixed-rate mortgages are more expensive i.e. interest rate on a 30-year fixed-rate loan will be higher than a 15-year fixed-rate mortgage
- Initial interest rate on ARM is lower than any fixed-rate mortgage i.e. interest rate for the first 5 years on a 5/1 ARM will be lower than the interest rate on a 15-year fixed-rate mortgage. So monthly payments will be lower with ARM loans initially.
Risk
The risk with an ARM is that the rate of interest (and therefore, monthly payments) may rise over the lifetime of the loan. The low interest rates on ARM may not last beyond the initial period. So when interest rates are low, it may be tempting to lock them in with a fixed-rate mortgage.
Correspondingly, the risk with a fixed-rate mortgage is that interest rates may either fall or stay low for an extended duration. While a borrower can usually refinance to take advantage of lower interest rates, there may occasionally be a prepayment penalty for closing out the loan (now rare on conforming loans), and there are always fees (closing costs, appraisal fee etc.) associated with refinancing.
Pros and Cons
With a fixed rate mortgage loan, you can be certain of the amount you owe the bank on a monthly basis. It remains the same through the entire term of your loan, never stressing you out if there is a fluctuation in the market. A variable rate mortgage on the other hand, gives you the option to pay less interest, if the market conditions are favorable. Also, ARMs come with caps that limit how high the interest rate can be raised — both at each reset (the periodic cap) and over the life of the loan (the lifetime cap). In this way, you are protected from unlimited rate increases. Due to lower monthly payments (at least in the first few years), ARMs are more affordable.
How to choose
Here are some tips to choose which mortgage to take:
- If interest rates are already very low and unlikely to go much lower, choose a fixed rate mortgage and lock in your interest rate.
- If you expect to repay a substantial portion of the principal in the early years, choose an adjustable rate mortgage. e.g. You take a $300,000 loan but are planning to repay $60,000 (as extra payments; over and above your monthly payments) in the first 3 years.
- If the lower interest rate on the ARM allows you to buy the home but the fixed-rate would raise monthly premiums too high, then be careful. Only take the ARM loan if you expect your income to rise in the future, because if your income does not rise and the interest rate resets higher after the initial period, then you will no longer be able to afford to make your payments.
- Keep in mind that lenders qualify ARM borrowers at the highest rate the loan could reach in its first few years, so an ARM will not always let you borrow more than a fixed-rate loan would.
- Always try and choose loans that do not have a prepayment penalty. This gives you more flexibility to refinance if interest rates fall.
Popularity
The United States of America is one country where fixed rate mortgages are more popular. United Kingdom, Australia and New Zealand are countries where variable rate mortgages are more popular than the fixed rate mortgages.
References
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APR 
Annual Percentage Rate 
Pre-qualified 
Fannie Mae 
Condo 
Judicial Foreclosure
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