Adjustable-Rate Mortgage vs. Fixed-Rate Mortgage: Which Works Best for You?

Comparing a fixed-rate loan to an ARM may appear complex, but it can be simplified by understanding both types of financing.

When considering homeownership, there are a lot of decisions to make. In addition to picking out the best neighborhood and home features, there’s another huge factor to consider — the mortgage type. Adjustable-rate mortgages and fixed-rate mortgages are both common options on the market, and they both have unique benefits. Understanding the benefits and risks of an adjustable-rate mortgage versus a fixed-rate mortgage can make it easier to check this decision off of any potential homebuyer’s to-do list.

What Is an Adjustable-Rate Mortgage (ARM)?

An adjustable-rate mortgage is a home loan that comes with two types of interest rates. Adjustable-rate mortgages have a fixed interest rate for the first few years, followed by a variable interest rate. The variable interest rate is based on market conditions and can change at monthly or yearly intervals throughout the remainder of the mortgage term. 

Advantages of Adjustable-Rate Mortgages

There are some notable advantages of adjustable-rate mortgages. When comparing interest rates, homebuyers may notice that adjustable-rate mortgages tend to have lower starting interest rates than fixed-rate mortgages. This means that a homebuyer who chooses to finance using an ARM can enjoy lower monthly payments for the fixed period of the ARM. For this reason, adjustable-rate mortgages can be a good option for homebuyers who are planning for short-term ownership. 

Disadvantages of Adjustable-Rate Mortgages

The downside of adjustable-rate mortgages is that they come with a certain level of uncertainty. No matter how appealing the initial interest rate is, eventually, the interest rate of an ARM will start to change. If market conditions are unfavorable, there is the possibility of higher interest rates, leading to higher monthly payments. In some cases, this could cause financial strain for borrowers. Homebuyers who intend to own a home for a longer period should carefully consider this risk when choosing a mortgage type. 

What Is a Fixed-Rate Mortgage?

A fixed-rate mortgage is a type of home loan that features a fixed interest rate for the entirety of the loan term. With this mortgage type, homebuyers will be given an estimate of the interest rate that they are approved for when they are preapproved for a mortgage. This interest rate can fluctuate based on the market conditions up until the time that the rate is locked in during the final stages of the homebuying process. 

After a homebuyer has an accepted purchase contract, they can submit their fixed-rate mortgage loan application. At this point, the lender will provide the homebuyer with a loan estimate, which will include the interest rate. Homebuyers then have the option to lock in the interest rate and know exactly what their monthly mortgage payments will be. 

Advantages of Fixed-Rate Mortgages

Fixed-rate mortgages are the preferred mortgage type for many homebuyers, especially those who are planning to own the home for a long time. This mortgage type offers stability and protection against rising interest rates that can greatly increase monthly mortgage payments. The stability of fixed monthly payments can provide a peace of mind that is priceless. 

Disadvantages of Fixed-Rate Mortgages

While fixed-rate mortgages offer predictability and stability that are attractive to many, there are some disadvantages to consider as well. When comparing fixed-rate mortgages against ARMs, you’ll likely see that fixed-rate mortgages have higher interest rates than the going rate of an ARM. So while a fixed-rate mortgage could help a homebuyer save money on their interest payments in the long run, it also means higher monthly payments in the initial years of homeownership. 

Additionally, there is always the chance that interest rates could fall during the life of the loan. Unless someone with a fixed-rate mortgage refinances to get a lower interest rate, falling interest rates will not benefit them. 

Similarities and Differences Between Adjustable-Rate Mortgages and Fixed-Rate Mortgages

Both adjustable-rate mortgages and fixed-rate mortgages are designed to help homebuyers achieve homeownership and pay for their homes over years or decades. While there are some similarities, there are also differences that borrowers need to consider. 

Potential to Be Refinanced

Regardless of whether a homeowner has an adjustable-rate mortgage or a fixed-rate mortgage, they may be able to refinance the mortgage. Borrowers might want to consider refinancing if their financial situation has improved since taking out the original mortgage. They might also want to consider refinancing if interest rates have changed. In both cases, borrowers might be able to qualify for a lower interest rate and lower their monthly mortgage payments. 

Credit and Income Qualifications

Both mortgage types have qualifying criteria that borrowers must meet to get approved. This includes a minimum credit score and income requirements. 

Interest Rate

Adjustable-rate mortgages and fixed-rate mortgages both come with an interest rate. The biggest difference between these mortgage types is the interest rate structure of each. Both mortgage types start with a fixed interest rate, but ARMs eventually move out of the fixed-rate period. The interest rate of an ARM then adjusts regularly based on current market conditions.

Rate Stability

While both mortgage types start with a fixed interest rate, which offers stability for borrowers, ARMs do not offer continued rate stability. An ARM is subject to changes in the market which can increase or decrease the interest rate of the loan. As the interest rate changes, so does the amount a borrower must pay each month. Fixed-rate mortgages, on the other hand, offer rate stability throughout the entire loan term. This results in monthly mortgage payments that remain the same as well, making it easier for borrowers to keep their budgets consistent. 

Risk and Flexibility

ARMs offer homebuyers a higher amount of both risk and flexibility. Because they come with an interest rate that is typically lower at least for the initial period of the loan, they offer the benefit of lower monthly mortgage payments. This is especially useful at the start of a mortgage when new homeowners might appreciate more flexibility in their budget to cover home repairs or other expenses associated with buying a new home. 

The risk of ARMs is that after the initial fixed interest period, borrowers have to face the possibility of rising interest rates increasing their monthly mortgage payments. For some, this risk is worthwhile, but some borrowers might be more comfortable with the stability and reduced risk that comes with a fixed-rate mortgage.

Loan Duration 

Another major difference between ARMs and fixed-rate mortgages is the mortgage term, which is the amount of time over which the mortgage is meant to be paid off. Both loans can have a total loan duration of 15 or 30 years. However, ARMs have drastically shorter fixed-rate periods that are typically only 3, 5, 7 or 10 years.

Market Conditions

After securing a fixed-rate mortgage, market conditions will not have an impact on that mortgage. However, borrowers who have an adjustable-rate mortgage need to familiarize themselves with the impact market conditions can have on their monthly payments. The interest rate of ARMs is determined by market conditions after the initial fixed-rate period has come to an end. 

Compare the Best Fixed and Adjustable-Rate Mortgage Lenders From Benzinga's Top Providers

Carefully assessing the list of top mortgage lenders for both ARM and fixed-rate offerings will help you make an informed decision based on your financial goals and risk tolerance.

Making the Decision: Fixed vs. Adjustable-Rate Mortgage

There are a lot of factors to consider, and there is no right or wrong answer. Every borrower needs to consider their financial situation as well as their homeownership goals and the amount of risk they are willing to take. To help make the decision easier, borrowers should discuss their options with their lender and compare interest rates. Studying and understanding market conditions can also help borrowers assess the risks they may take on, depending on the mortgage type that they choose.

Frequently Asked Questions