ARM vs. Fixed-Rate Mortgage: Which One Is Right for You?

Many homebuyers default to a 30-year fixed mortgage, but that’s not the only option. While a fixed-rate mortgage ensures a set payment for the entire loan term, an adjustable-rate mortgage (ARM) may allow you to make lower principal and interest payments, especially in the early years of your mortgage.

The right option for you will depend on how long you plan to stay in your home and your comfort with payment variability. If you don’t plan to be in a home for decades and you’re willing to accept fluctuating payments, an ARM could save you money.

Keep in mind that specific eligibility requirements, down payment minimums and loan terms vary by lender — this guide is a general overview. Talk with a mortgage banker to understand the options available to you.

What Is a Fixed-Rate Mortgage?

With a fixed-rate mortgage, your interest rate stays locked for the entire loan term and your monthly principal and interest payment never changes.

The two most common terms for a mortgage are 30 years and 15 years. If you opt for a 30-year fixed or a 15-year fixed mortgage, you can expect the same principal and interest payment every month until the end of the term.  Fixed-rate mortgages offer total predictability and are ideal for long-term owners.

What Is an Adjustable-Rate Mortgage?

An adjustable-rate mortgage (ARM) includes an interest rate that may fluctuate over time. An ARM has an initial fixed-rate period, such as five or seven years, after which the rate adjusts periodically based on current mortgage rates plus a set margin. Most adjustable-rate mortgages adjust based on the Secured Overnight Financing Rate (SOFR), which measures the cost of borrowing cash overnight against U.S. Treasury securities.

Adjustable-rate mortgage options are often named for the time between rate adjustments. For example, a 5/1 ARM means the rate is fixed for five years and then adjusts every year.

While the rate you pay for an ARM will fluctuate over time, they can be attractive because the initial rate is typically lower than a comparable fixed-rate mortgage. As a result, homeowners who plan to sell their homes within a short time frame, such as five years, may be able to save money with an ARM because they won’t have the mortgage long enough to experience the rate adjustments.

Common ARM Types

Some of the types of adjustable-rate mortgages you may hear about most often include:

• 5/1 ARM. The most common ARM is fixed for five years and adjusts annually after that.
• 7/1 ARM. Fixed for seven years, the rate then adjusts annually.
• 10/1 ARM. This type of ARM has the longest fixed period of 10 years and offers a rate closest to a 30-year fixed mortgage.

There are also other ARMs that adjust every six months rather than annually. For example, a 5/6 ARM offers a fixed rate for five years and then adjusts every six months.

How ARM Rate Adjustments Work

Rate adjustments can change your monthly payment, but understanding how they work can help you plan. After the fixed period ends, the new rate is recalculated as: market index + lender’s margin.

The market index fluctuates based on the Secured Overnight Financing Rate Secured Overnight Financing Rate (SOFR ), determined by the Federal Reserve Bank of New York. But the lender’s margin is set at the start of the mortgage loan and never changes.

For example, if your lender’s margin is 2%, and the SOFR rate is 4%, your adjustable mortgage rate would be 6%. If the SOFR rate drops to 3% the following year, with the additional 2% lender’s margin, your adjustable rate would drop to 5%. And if the SOFR rate increases to 6% the next year, your rate would rise to 8% with the lender’s margin.

Most ARMs include rate caps, which limit how much the rate can change. These are safeguards included in your loan agreement to protect you from an exorbitant rate, and without them, your monthly payments could fluctuate heavily with the market.

Rate caps are often written as a three-number sequence, such as 2/2/5. The numbers represent three types of rate caps, according to the Consumer Financial Protection Bureau:

• Initial adjustment cap governs how much the interest rate can change at the first adjustment period following the fixed rate period. It’s common for this cap to be 2%, meaning the interest rate can adjust no more than 2% up or down at the first adjustment period.
• Subsequent adjustments cap says how much the rate can be adjusted at subsequent adjustment periods, such as 1% or 2% higher or lower than the previous period.
• Lifetime adjustment cap shows how much the interest rate can increase or decrease in total over the life of the loan. For example, if the lifetime adjustment cap is 5%, the interest rate cannot ever be higher or lower than five percentage points different from the initial rate. In some cases, the lifetime cap is for interest rate increases only, and a different number governs the “floor,” or the lowest the interest rate can go.
  

ARM vs. Fixed Rate: Key Differences

	Interest Rate Type	Payment Predictability	Risk Level	Ideal Time Horizon	Down Payment Requirements
Adjustable-Rate Mortgage	Adjustable	Predictable for the first period, such as five years, and fluctuates after that	Higher	Shorter term, such as five or 10 years	Typically require a minimum of 5% down payment
Fixed-Rate Mortgage	Fixed	Never changes throughout the life of the loan	Lower	Long-term, typically 15 or 30 years	Typically require a minimum of 3% down payment

One practical difference to keep in mind: Conventional ARMs typically require a minimum 5% down payment, compared to 3% for most conventional fixed-rate loans. If your down payment savings are limited, a fixed-rate loan may give you more flexibility.

When Does an ARM Make Sense?

An adjustable-rate mortgage may be a good idea if you plan to sell, pay off, or refinance the home before the end of the initial fixed period. For example, if you can get a 5/1 ARM for an initial 5% interest rate, or a 30-year, conventional fixed-rate mortgage with a 6% interest rate, you’ll save money with the ARM if you plan to stay in the house for less than five years.

An ARM can also make sense if you’re comfortable with some payment variability in exchange for a lower starting rate, or if you want to maximize your buying power with lower initial payments.

Your ownership horizon is the single most important factor in this decision. If this is your forever home, the stability of a fixed rate typically outweighs any short-term savings from an ARM. If you expect to sell or move within five to seven years, an ARM’s introductory period may align perfectly with your plans.

A useful way to decide is to calculate your break-even point: take the monthly savings from the ARM’s lower initial rate and divide that into the difference in total interest you pay over the fixed period. If you plan to sell or refinance before you break even, the ARM can save you money. For example, if an ARM saves you $150 a month compared to a 30-year fixed, and you plan to move in four years, you will save roughly $7,200 before any rate adjustment takes effect — assuming rates stay flat.

When Does a Fixed-Rate Mortgage Make More Sense?

A fixed-rate mortgage often makes sense when you plan to stay in the home for the long term. It also makes sense for homebuyers who want total payment predictability and stability.

Also, if you would struggle to afford higher payments if the ARM were to adjust upward, a fixed-rate mortgage is a better choice.

What Are the Risks of an ARM?

While an ARM can save money for some homebuyers, it also carries some risks, including:

• The rate can increase meaningfully after the fixed period. While rate caps provide protection, they don’t eliminate risk.              
• It’s more difficult to budget for the long term after rate adjustments begin.
• While you can refinance to escape a rising rate, your new loan may have a significantly higher rate.
• If rates rise significantly after your fixed period ends, you do have the option to refinance into a fixed-rate mortgage — but plan for closing costs that typically range from 2% to 5% of the loan balance. Factoring that cost into your long-term planning is especially important if you expect to still own the home when adjustments begin.

Before committing to an ARM, calculate your maximum possible monthly payment at the lifetime cap. If you can’t afford that maximum payment, consider a fixed-rate mortgage.

ARM vs. Fixed-Rate FAQs

Which type of mortgage do most homebuyers choose and why?

Most homebuyers choose a fixed-rate mortgage for either 15 years or 30 years, likely because that is the default for most lenders, the terms are easy to understand and explain, and fixed-rate loans allow for long-term budgeting.

When is an ARM a better choice than a fixed rate?

An ARM can be a better choice if you plan to sell, pay off or refinance the mortgage before the initial fixed term ends. It may also be a good choice if you’re comfortable with payment variability and want to start out with a lower payment during the initial fixed term period.

What is a 5/1 ARM?

A 5/1 ARM is an adjustable-rate mortgage loan with a fixed rate for the first five years, which will then adjust annually.

What are the risks of choosing an ARM?

The rate can increase meaningfully after the fixed rate period ends, and periodic rate adjustments can make budgeting difficult.