Fixed-Rate vs. Adjustable-Rate Mortgages: What's the Difference?

1 day ago

6 min read

When you buy a home, one of the biggest decisions you'll make is choosing your mortgage. And beyond deciding how much to borrow and how long you'll take to pay it back, you'll need to understand how your interest rate works.

Two common mortgage options are fixed-rate and adjustable-rate mortgages.

The main difference is pretty simple: With a fixed-rate mortgage, your interest rate stays the same throughout the agreed loan term. With an adjustable-rate mortgage, your interest rate can change over time, which means your monthly payment may change too.

Both options have advantages and drawbacks. Understanding how they work can help you decide which one makes more sense for your finances and how long you plan to keep the home.

TL;DR: For a quick summary of the article click here.

What Is a Fixed-Rate Mortgage?

A fixed-rate mortgage has an interest rate that stays the same for the entire loan term.

For example, if you borrow $250,000 with a 30-year fixed-rate mortgage at 6%, your interest rate will remain 6% for those 30 years unless you refinance into a different loan.

Your principal and interest payment will also remain the same.

Principal is the original amount of money you borrowed.

Interest is what the lender charges you for borrowing it.

As you make monthly payments, part of the money goes toward the original loan amount and part goes toward interest.

Why buyers choose fixed-rate mortgages:

Predictable payments: Your principal and interest payment won't increase because of changing interest rates.
Easier budgeting: You know what to expect from your mortgage payment.
Long-term stability: You don't have to worry about market interest rates increasing your loan rate.
Protection from rate increases: Even if mortgage rates rise significantly, your existing rate stays the same.

One thing to remember is that your total monthly housing payment can still change. Property taxes and homeowners insurance may increase, and those expenses are often included in your monthly mortgage payment through an escrow account.

What Is an Adjustable-Rate Mortgage?

An adjustable-rate mortgage, commonly called an ARM, starts with an interest rate that can change after an initial period.

For example, you might see a mortgage advertised as a 5/1 ARM.

That means:

The interest rate stays the same for the first five years.
After those five years, the rate can adjust once each year.

Other options include 7/1 and 10/1 ARMs, which have different initial fixed-rate periods.

During the initial period, your payment is generally based on the starting interest rate. Once that period ends, the lender can adjust the rate according to the terms of your loan.

Why would the interest rate change?

Adjustable-rate mortgages are typically tied to a financial market index. The index is a measurement lenders use to determine how interest rates are changing.

Your loan also includes a margin, which is an additional percentage added to that index to calculate your new interest rate.

For example, if the index is 3% and your loan's margin is 2.5%, your adjusted interest rate would be 5.5%, subject to the loan's adjustment rules and limits.

In simple terms, if the financial market changes, your interest rate will also change.

Why would it go up or down?

Interest rates can change based on things happening in the economy, such as:

Inflation: When the cost of everyday goods and services keeps rising, interest rates may rise as well to help slow spending and bring inflation under control.
Federal Reserve decisions: The Federal Reserve (often called the Fed) influences borrowing costs by raising or lowering its benchmark interest rate.
Economic conditions: Changes in the economy, financial markets, and the cost of borrowing money can all affect the rates used in mortgage indexes.

If interest rates rise, your mortgage rate and payment may increase.

If rates fall, your rate and payment may decrease.

Most ARMs also have limits on how much the interest rate can increase at each adjustment and over the life of the loan. These are called rate caps.

Why buyers choose adjustable-rate mortgages:

Lower starting rates: Some ARMs begin with a lower interest rate than comparable fixed-rate mortgages.
Lower initial payments: A lower starting rate may reduce your monthly principal and interest payment during the introductory period.
Potential savings: If you sell or refinance before the adjustable period begins, you may benefit from the lower initial rate.
Potential rate decreases: If market rates fall, your payment may decrease when the loan adjusts.

The important thing is to understand that the starting rate isn't necessarily the rate you'll have for the rest of the mortgage.

Fixed-Rate vs. Adjustable-Rate Mortgages

Here's a side-by-side comparison of the two options.

Feature	Fixed-Rate	Adjustable-Rate
Starting interest rate	Stays the same	Usually stays the same during the introductory period
Future interest rate	Does not change	Can increase or decrease
Monthly principal and interest	Predictable	Can change after adjustments
Initial payment	May be higher	May start lower
Long-term planning	More predictable	Requires planning for possible increases
Best suited to	Buyers who value payment stability	Buyers comfortable with changing payments and future rate uncertainty

What Happens When an Adjustable Rate Changes?

This is where buyers really need to pay attention.

Let's say you take out a 5/1 ARM with an initial interest rate of 5.5%. Your rate stays at 5.5% for the first five years.

When the introductory period ends, the lender recalculates your rate using the index, margin, and adjustment limits in your agreement.

If the new rate is higher, your monthly principal and interest payment can increase.

For example, imagine you owe $250,000 at the time of adjustment and have 25 years remaining on your mortgage.

Interest Rate	Approximate Monthly Principal and Interest
5.5%	$1,535
6.5%	$1,689
7.5%	$1,847
8.5%	$2,014

These are illustrative estimates, not actual loan quotes. They assume the same $250,000 balance and 25-year repayment period at each rate.

As you can see, even a relatively small interest rate increase can make a noticeable difference in your monthly payment.

Before choosing an ARM, ask your lender for examples showing what your payment could look like if interest rates increase to the maximum allowed under your loan.

Don't base your decision entirely on the introductory payment.

Which Mortgage Should You Choose?

Your finances, future plans, and comfort with changing payments all matter when comparing mortgage options.

A fixed-rate mortgage may make more sense if:

You plan to stay in the home for many years.
You prefer predictable monthly payments.
You want protection against rising interest rates.
You have a budget that doesn't leave much room for payment increases.

An adjustable-rate mortgage may be worth considering if:

You expect to move or sell before the initial fixed-rate period ends.
You can comfortably handle a higher payment if rates increase.
The starting rate offers meaningful savings.
You understand the adjustment schedule and maximum possible rate.

One important distinction: You shouldn't assume you'll be able to refinance an ARM before the rate changes. Refinancing requires qualifying for a new mortgage, and your income, credit, home value, and available interest rates may be different by then.

Compare the full loan terms, not just the initial monthly payment.

Questions to Ask Before Choosing a Mortgage

Before signing anything, ask your lender to explain exactly how your mortgage works.

Here are some questions worth asking:

How long will my initial interest rate stay the same?
What will my starting monthly payment be?
How much could my payment increase?
How often can the interest rate change?
What is the highest interest rate allowed under this loan?
What financial index is used to calculate adjustments?
Are there fees or penalties for paying off the mortgage early?
What would refinancing involve if I decide to change mortgages later?

If you're comparing multiple lenders, ask for the same information from each one. This makes it easier to compare the actual costs and terms rather than focusing on whichever loan has the most attractive advertised rate.

Too Long, Didn't Read Recap

Fixed-rate and adjustable-rate mortgages both allow you to finance a home, but they handle interest rates differently.

Fixed-rate mortgage: Your interest rate stays the same throughout the loan term, making your principal and interest payments predictable.
Adjustable-rate mortgage (ARM): Your rate starts out fixed but can increase or decrease after an introductory period.
Lower starting payments: ARMs may offer lower initial interest rates, but payments can increase later.
Rate limits: Most adjustable-rate mortgages have rules limiting how much the rate can increase.
Think long-term: Consider how long you plan to keep the home, what you can afford, and whether you could handle a higher payment.
Compare loan terms: Look beyond the advertised interest rate and understand how the mortgage works over time.

The biggest difference comes down to predictability versus flexibility. A fixed-rate mortgage offers a consistent interest rate, while an adjustable-rate mortgage gives you a starting rate that may change later.

Up Next: Learning about the types of mortgages can be helpful, but so can looking into different types of home buying programs which may not be the same as the two options here. In the next article we look at first time homebuyer programs that can help make homebuying more affordable, and with potentially better repayment terms.