How Fixed-Rate Mortgages Work
With a fixed-rate mortgage, the interest rate is set when you take out the loan and will not change for the entire term. As a result, your monthly principal and interest payment stays the same for the life of the loan, making it easier to plan long-term budgets.
Fixed-rate mortgages are available in a variety of terms, with 15, 20, and 30 years being common options. While the interest rate remains constant, your total monthly payment can still change if property taxes or homeowners insurance premiums change, since those are often escrowed as part of your payment.
Because the lender assumes the risk that market rates might rise, fixed-rate mortgages typically start with a higher initial interest rate than comparable adjustable-rate mortgages.
- Interest rate never changes.
- Principal and interest payment remains stable.
- Common terms include 15, 20, and 30 years.
- Payment can change if taxes or insurance costs change.
Sources: Consumer Financial Protection Bureau, Nusenda Credit Union
How Adjustable-Rate Mortgages Work
An adjustable-rate mortgage (ARM) has an interest rate that may go up or down after an initial fixed-rate period. That initial period can last for months, one year, or a few years, and after it ends, the rate adjusts on a regular schedule—for instance, every year or every six months.
The rate on an ARM is typically based on a specific index plus a margin. When the index changes, your interest rate can change, which in turn affects your monthly principal and interest payment. Many ARMs start with a lower initial rate than comparable fixed-rate mortgages, which can make them appealing for short-term homeownership.
However, because the rate can increase, your payment may rise significantly after the initial period, and you may face higher costs than you originally budgeted for.
- Initial fixed-rate period lasts months or years.
- Rate adjusts at regular intervals (e.g., annually).
- Rate is usually tied to an index plus a margin.
- Payment can increase or decrease over time.
Key Features Comparison
The table below highlights the main differences between fixed-rate and adjustable-rate mortgages.
| Attribute | Fixed-Rate Mortgage | Adjustable-Rate Mortgage (ARM) |
|---|---|---|
| Interest rate | Fixed for the life of the loan | Adjusts after initial fixed period |
| Initial rate | Typically higher than ARM initial rate | Typically lower than fixed-rate mortgage |
| Monthly payment (principal and interest) | Stays the same | Can increase or decrease after initial period |
| Risk | Lower risk, no surprises | Higher risk, uncertainty |
| Best for | Long-term homeownership and stable budgeting | Short-term homeownership or plans to refinance before rate adjusts |
Sources: Consumer Financial Protection Bureau
Scenarios: When Each Might Be Better
Your choice between a fixed-rate and an adjustable-rate mortgage depends on how long you plan to stay in the home and your comfort with payment variability.
A fixed-rate mortgage may be the better choice if you value predictable payments and plan to stay in your home for many years. Because the rate never changes, you are protected against future interest rate increases, which can help with long-term budgeting.
An ARM might be more appropriate if you plan to sell or refinance before the initial fixed-rate period ends. The lower initial rate could mean lower payments in the early years, but you should be confident you can handle potential payment increases if your plans change.
For example, a 5/1 ARM offers a fixed rate for the first five years, then adjusts once per year. A 10/6 ARM keeps a fixed rate for ten years and then adjusts every six months. If you expect to move or refinance within that initial window, an ARM could save you money.
- Fixed-rate: ideal for long-term stability and predictable budgeting.
- ARM: attractive for short-term ownership or plans to refinance before the rate adjusts.
- 5/1 ARM: fixed for 5 years, then adjusts annually.
- 10/6 ARM: fixed for 10 years, then adjusts every 6 months.
Sources: Consumer Financial Protection Bureau, U.S. Bank, Alliant Credit Union, Nusenda Credit Union
Risks of ARMs
Adjustable-rate mortgages carry specific risks that borrowers should understand. The most significant is payment shock—the possibility that your monthly payment could increase substantially when the rate adjusts, especially if interest rates have risen since you took out the loan.
Because your payment may change, budgeting can become more difficult, and you might face higher costs than you initially anticipated. Some ARMs also include provisions that can lead to negative amortization, where your loan balance grows even as you make payments, though this is not typical of all ARMs.
The CFPB warns that borrowers should not assume they can refinance or sell the home before an ARM's rate increases. If interest rates rise, you might not be able to refinance or sell as easily as planned, and you could be stuck with higher payments. Make sure you can afford the highest possible payment, not just the initial rate.
- Payment shock when rates rise.
- Difficulty budgeting due to changing payments.
- Negative amortization risk in some ARMs.
- No guarantee you can refinance or sell before adjustment.
Sources: Consumer Financial Protection Bureau, Nusenda Credit Union
How to Choose
Choosing between a fixed-rate and adjustable-rate mortgage involves weighing your financial goals and your tolerance for risk.
Ask yourself how long you expect to stay in the home. If you plan to remain for many years and value predictable monthly payments, a fixed-rate mortgage provides peace of mind. If you are fairly certain you will move or refinance within a few years, an ARM might offer a lower initial rate and lower payments during that time.
Also consider your ability to handle potential payment increases. If a higher payment would strain your budget, a fixed-rate mortgage may be safer. And remember, you should never count on being able to refinance before the rate adjusts—make sure you can afford the loan even if rates rise significantly.
- Estimate your expected time in the home.
- Compare initial rates and potential future adjustments.
- Assess your budget's flexibility for higher payments.
- Do not assume you can refinance or sell before rates change.
Sources: Consumer Financial Protection Bureau, Nusenda Credit Union
decision-criteria matrix
The following matrix summarizes the key factors to consider when comparing fixed-rate and adjustable-rate mortgages.
| Criterion | Fixed-Rate Mortgage | Adjustable-Rate Mortgage |
|---|---|---|
| Payment predictability | High | Low to moderate |
| Initial interest rate | Typically higher | Typically lower |
| Long-term cost certainty | High | Low |
| Risk of future payment increases | None | Possible |
| Best for | Long-term homeowners | Short-term homeowners or those who may refinance early |
Sources: Consumer Financial Protection Bureau, Nusenda Credit Union
Frequently asked questions
How often can an ARM's rate change?
After the initial fixed-rate period, an ARM's interest rate can adjust at regular intervals, such as every year or every six months. The specific frequency depends on the ARM's structure; for example, a 5/1 ARM adjusts once per year, while a 10/6 ARM adjusts every six months.
Sources: Consumer Financial Protection Bureau, U.S. Bank, Alliant Credit UnionWhat is a 5/1 ARM?
A 5/1 ARM is an adjustable-rate mortgage with a fixed interest rate for the first five years. After that, the rate adjusts once per year. Many ARMs start with a lower initial rate than comparable fixed-rate mortgages, but the rate can increase or decrease after the initial period.
Sources: Consumer Financial Protection Bureau, U.S. BankCan I switch from an ARM to a fixed-rate mortgage later?
You may be able to refinance an ARM into a fixed-rate mortgage, but there is no guarantee. Refinancing depends on factors like your credit, current interest rates, your home's value, and your lender's requirements. The CFPB advises that you should not assume you can refinance before an ARM's rate increases; it is important to ensure you can handle higher payments if needed.
Sources: Consumer Financial Protection BureauSources
- Consumer Handbook on Adjustable-Rate Mortgages — Consumer Financial Protection Bureau
- What is the difference between a fixed-rate and adjustable-rate mortgage (ARM) loan? — Consumer Financial Protection Bureau
- Understand the different kinds of loans available — Consumer Financial Protection Bureau
- Adjustable-rate mortgage (ARM) vs Fixed-rate mortgage — U.S. Bank
- 10/6 ARM vs. a 30-Year fixed Mortgage - Which is Best? — Alliant Credit Union
- Fixed vs Adjustable Rate Mortgage | Pros & Cons — Nusenda Credit Union