Should I Get a Fixed-Rate or an Adjustable Rate Mortgage?

Fixed-Rate Mortgages Give You Stability Over Time

A fixed-rate mortgage locks your payment for the life of the loan, whether that’s 15 years or 30. The rate gets set at closing and it doesn’t budge after that. For anyone juggling a tight household budget, that predictability alone can be worth a lot.

Take a $250,000 loan at 3.67% over 30 years. Monthly principal and interest comes out to $1,110. Month 1, month 200, month 360, the number never changes.

Run that out five years and you’ve paid $66,600. Now imagine rates climbed to 4.5% by year six instead, on a comparable loan, you’d be looking at $68,200 over the next five years, more than $1,600 extra per year. A fixed rate sidesteps that risk completely.

The Consumer Handbook on Adjustable-Rate Mortgages points out that fixed loans suit borrowers focused on long-term planning. Teachers, healthcare workers, government employees, anyone with steady, predictable income tends to do well with this structure.

There’s a catch, though. You don’t get to benefit when rates fall, not without refinancing. Say rates dropped to 3.0% a year after you closed. Your payment stays exactly where it was. Lowering it means going through a new credit check, a new appraisal, and closing costs that typically run $1,500 to $3,000, according to Experian.

Even with that drawback, fixed-rate loans dominate the market. Back in November 2013, more than 86% of all mortgage originations were fixed-rate, per the Mortgage Bankers Association MBA report.

Adjustable-Rate Mortgages Trade Lower Payments for More Risk

ARMs dangle a lower rate for an introductory stretch, commonly 3, 5, 7, or 10 years, then start adjusting annually based on whatever benchmark index the loan is tied to.

The 5/1 ARM is the one you’ll see most often: five years fixed, then yearly changes after that. Back in November 2013, these loans typically opened at 2.8% to 3.2%, running 0.5% to 0.8% below the average 30-year fixed rate Freddie Mac PMMS.

That gap can translate into real purchasing power. Picture a buyer making $60,000 a year with a front-end debt-to-income ratio of 36%. That borrower might qualify for a $320,000 loan under a 5/1 ARM but only $280,000 with a 30-year fixed.

Here’s where it gets tricky. Once the fixed period ends, your rate can climb. The Fed’s benchmark rate sat at 0.25% back then, but if it moves up to, say, 1.5%, your ARM’s index will likely follow. Lenders calculate your new rate by adding a margin (2.5% is typical) to that index value. Index goes up, your payment goes up right along with it.

ARMs fall under rules laid out in the Consumer Handbook on Adjustable-Rate Mortgages, which forces lenders to spell out the worst-case rate and payment scenario upfront. FHA-insured ARMs, for instance, cap annual increases at 1% and lifetime increases at 5% over the starting rate HUD ARM Guidelines.

Here’s a concrete scenario. Say you’ve got a 5/1 ARM starting at 2.8% with a 2.5% margin, and the index climbs to 2.0%. Your new rate lands at 4.5%, a jump of 1.7 percentage points. On a $300,000 loan, that pushes your payment from $1,085 to $1,420, a $335 monthly swing. Annualized, that’s an extra $4,020 out of your pocket. Knowing that worst-case number before you sign matters more than the teaser rate does.

An ARM Can Make Sense in the Right Situation

If you’re planning to sell or refinance before the first adjustment hits, an ARM starts to look pretty attractive. Buying in a fast-growing market like Austin or San Francisco and expecting to move within 5 to 7 years? An ARM can shrink your monthly costs while you’re actually living there.

That approach only really pays off with solid credit behind it. A FICO Score of 740 or higher improves your odds of refinancing into a good rate later, even if the broader market has moved up Experian. Chase, Wells Fargo, and SoFi all lean on FICO scores when sizing up risk.

Good credit doesn’t guarantee anything, though. Fed policy shifts, tighter lending standards, or falling home values can all shut the door on refinancing. Back in 2009, the FDIC found that 27% of refinancing applicants were denied, largely due to credit or income problems that had worsened FDIC report.

Consider a borrower with a 620 FICO score looking for a $300,000 loan and planning to stay put for five years. An ARM might look tempting on paper. But scores under 700 usually mean steeper terms. Lenders may still approve it, just with a wider margin attached, something like a 5/1 ARM at 3.2% with a 2.75% margin. The rate caps offer some protection, but not much cushion if rates move against you.

One more wrinkle worth knowing: the “look-back” or “reset” period. Some ARMs base adjustments on the index value from a year earlier. If rates spiked during that window, your payment can jump fast, even if you’ve only owned the home a short while.

A Fixed-Rate Loan Wins Out for Long-Term Owners

If you’re planning to stay put for more than a decade, a fixed-rate mortgage protects you from whatever happens to rates down the road. Lock it in now, and future increases simply don’t touch you.

That protection matters even more as retirement approaches. A payment that never changes takes one variable off the table during years when income might shrink. The CFPB has noted that retirees face outsized exposure to payment shocks, particularly on a fixed income CFPB CHARM booklet.

Qualifying is simpler too. Lenders lean on your monthly payment to work out your debt-to-income ratio, and a fixed payment gives them a stable number to calculate against. With an ARM, underwriters often plug in the maximum possible payment after adjustments, which makes approval a tougher hurdle to clear.

A 5/1 ARM carrying a 2.5% margin against a 3.5% index, for example, could see payments jump as much as 40% after the first reset, depending on where rates land. Lenders have to bake that possibility into their DTI math from day one.

If your budget has no room for a payment increase, a fixed loan keeps that risk off your plate entirely. ARMs just aren’t a great fit for borrowers without savings to fall back on. The CFPB has been blunt about this: rate shocks can push households toward foreclosure CFPB CHARM booklet.

Comparison: Fixed vs. Adjustable-Rate Mortgages

Frequently Asked Questions

What’s the difference between a fixed-rate and an adjustable-rate mortgage?

A fixed-rate mortgage keeps the same interest rate for the entire loan term. An ARM holds a fixed rate for an initial stretch, usually 3, 5, or 10 years, then adjusts annually against a financial index.

The Federal Reserve’s ARM Handbook notes that ARMs can lower your initial payment, but that comes bundled with uncertainty later on.

Can I switch from an ARM to a fixed-rate loan?

You can, but only by refinancing. That means reapplying, a fresh credit check, and closing costs. The CFPB requires a 30-day notice before your lender adjusts your rate CFPB Servicing Bulletin.

How much can an ARM payment increase?

On FHA-insured ARMs, the annual cap sits at 1%, with a lifetime cap of 5% above the starting rate. The Federal Reserve’s ARM Handbook spells out these limits in detail Federal Reserve.

Is it risky to get an ARM when rates are low?

It can be. Rates were unusually low in November 2013, with the 30-year fixed sitting at 3.67%. Should rates climb, particularly if the Fed raises the federal funds rate, your ARM payment could rise fast. The Federal Reserve H.15 data backs up just how real that risk is.

What credit score do I need for an ARM?

Most lenders want to see at least a 620 FICO Score. For the best pricing, aim for 740 or higher. Chase, Wells Fargo, and SoFi all pull FICO data during underwriting Experian.

Can I prepay an ARM without penalty?

Generally, yes. Unlike loans that carry prepayment penalties, most ARMs, including those from FHA, Chase, and SoFi, let you pay down principal early, in full or in part, without any fee.

Why do lenders prefer fixed-rate loans?

They’re simpler to manage on the servicing side, no ongoing rate resets, no complicated disclosures to track. The CFPB has pointed out that fixed-rate loans carry less servicing risk and hold up better in long-term loan portfolios CFPB CHARM booklet.

Can I get an ARM with a 15-year term?

Yes, some lenders offer it, including Wells Fargo and Quicken Loans. These usually pair a 5-year fixed period with annual adjustments afterward. They’re rarer than 30-year ARMs but available if your credit is strong enough.

What’s the average cost to refinance a mortgage?

, refinancing costs generally ran $1,500 to $3,000, covering appraisal fees, title search, and origination charges. Experian notes those costs can wipe out your savings if rates have only dropped slightly.

Is an ARM right for a first-time homebuyer?

Only if you’re fairly confident you’ll move within 7 years. First-timers should generally steer clear of ARMs unless they’re sure they’ll sell or refinance before that first adjustment lands. The CFPB warns plainly that rate shocks can lead to foreclosure CFPB CHARM booklet.