When it comes time to apply for a home loan, homebuyers have to choose between two types of mortgages — fixed and adjustable-rate mortgages.
The distinction between them is implied in their names: A mortgage borrower’s interest rate with a fixed-rate mortgage is constant for the whole term of the loan, whereas the rate for adjustable-rate mortgages is periodically adjusted over time.
The holy grail of mortgages is a locked-in, fixed-rate loan at a very low interest rate. Yet you can only secure such a loan when mortgage market conditions allow.
Right now, with mortgage rates well above 6%, many homebuyers who are taking out fixed-rate mortgages are doing so with the hope that they’ll be able to refinance in the future when rates come down.
But that’s not your only option. While fixed-rate mortgages are far and away the most popular type of loan, mortgage borrowers can also consider adjustable-rate mortgages, which aren’t as popular, but do have some advantages, especially when interest rates are high.
If interest rates drop, borrowers with adjustable-rate mortgages will see their rates come down. (On the other hand, if rates rise, so will their interest payments.) The other major benefit of an adjustable-rate mortgage is that the rates when you take out the loan are almost always lower than the rates for fixed-rate mortgages.
To help you decide between a fixed-rate and an adjustable-rate mortgage, here are some key factors to consider.
Table of Contents
- What is a fixed-rate mortgage?
- What is an adjustable-rate mortgage (ARM)?
- Which is better, a fixed or adjustable-rate mortgage?
- FAQs about fixed vs adjustable-rate mortgages
What is a fixed-rate mortgage?
A fixed-rate mortgage is a loan with a constant interest rate and monthly payment. These loans offer predictability to borrowers because they know what they’ll pay for their home each month for the life of the loan (aside from fluctuations in taxes, homeowners insurance and other secondary costs).
In other words, you don’t have to worry about the possibility of rising interest rates causing your monthly payment to go up.
Most homebuyers opt for fixed-rate mortgages. According to Freddie Mac, the 30-year fixed-rate mortgage is the most popular type of loan, and the stability they provide is the No. 1 reason why.
Shorter fixed-rate mortgages — for example, 15-year fixed-rate mortgages — have lower interest rates than the standard 30-year product. However, the monthly payments that come with shorter terms are simply too high for most people.
While fixed-rate mortgages have a lot working in their favor, the rates are higher compared to adjustable-rate mortgages. Still, most buyers decide that’s a compromise worth making.
Pros and cons of fixed-rate mortgages
- Predictability: Monthly payments don’t change
- You can lock in good mortgage rates when they’re low
- Higher initial rate compared to adjustable-rate mortgages
- Won’t benefit from falling rates unless you refinance
What is an adjustable-rate mortgage (ARM)?
Adjustable-rate mortgages offer lower introductory interest rates, but the rate isn’t fixed for the duration of the loan.
After an introductory period that lasts between six months and 10 years, your interest rate becomes a floating rate for the rest of the mortgage term. At that point, your interest rate will be adjusted regularly, often every year.
The rate adjustments depend on market conditions and your rate will be set according to a benchmark index chosen by the lender. When your rate gets adjusted, your monthly payment will change because you’re either paying more or less in interest. This is untenable for many mortgage borrowers because it can be very difficult to work a higher monthly payment into your budget.
Adjustable-rate mortgages do have interest-rate caps. There are lifetime caps that set the absolute max for your interest rate as well as periodic adjustment caps which limit how much your rate can go up in a particular adjustment period. So yes, your rate will fluctuate, but there are boundaries.
When interest rates are high, adjustable-rate mortgages tend to gain popularity as a share of the mortgage market. For one thing, the lower initial interest rate becomes more of a selling point. The other draw is that if rates come down in the future, your monthly payments will fall and you won’t have to refinance to capitalize on that.
Pros and cons of adjustable-rate mortgages
- Initial rates are lower compared to fixed-rate mortgages
- Borrowers benefit when mortgage rates fall
- Volatility: Monthly payments aren’t fixed for the life of the loan
- You have to pay more in interest when mortgage rates rise
Which is better, a fixed or adjustable-rate mortgage?
There’s no clear-cut answer to the question of which is better, fixed or adjustable-rate mortgages. Depending on how the mortgage market shakes out over the life of the loan, you might pay more in interest with a fixed-interest rate loan versus an adjustable-rate loan, or vice versa.
For a variety of reasons, including their stability, a strong majority of homebuyers opt for fixed-rate loans. In fact, less than 10% of mortgage originations are adjustable-rate loans, according to the Mortgage Bankers Association. But the best mortgage for you comes down to your personal financial situation and the real estate you’re buying.
Here are some of the key differences between fixed-rate mortgages and adjustable-rate mortgages:
Interest rate stability
Fixed-rate mortgages offer complete interest rate stability: You know what you’re going to pay each month until your mortgage is paid off. The exception would be if you refinance, and you’d usually do that to lock in a low rate.
Adjustable-rate mortgages have less interest-rate stability. However, there are limits on how much your rate changes, and the adjustments often happen on an annual basis, giving you time to plan. Also, your rate is fixed during the introductory period, which could be as long as 10 years.
Initial interest rate
Mortgage lenders typically offer lower interest rates for adjustable-rate mortgages compared to fixed-rate mortgages (assuming the loan term, home price, down payment and loan amount are the same). The initial offer is a tactic to entice borrowers, and the tradeoff is that if mortgage rates rise in the future, you’ll likely end up with a higher interest rate compared to what your rate would’ve been with a fixed-rate mortgage.
Level of risk
Taking out an adjustable-rate mortgage requires some comfort with risk given that your monthly payment will move up and down after the initial period. These mortgage loans may be better suited for borrowers who have some room in their budgets in case their rates rise, as well as borrowers who are comfortable taking some risk in exchange for a lower introductory rate and the possibility of lower monthly payments in the future if rates fall.
FAQs about fixed vs adjustable-rate mortgages
Which type of mortgage is better when rates are high?
Can you refinance a fixed-rate mortgage?
Why would you take an adjustable-rate mortgage over a fixed rate?