Fixed-Rate vs. Adjustable-Rate (ARM): How Each Works

What it is

A fixed-rate mortgage keeps the same interest rate for the entire loan term. An adjustable-rate mortgage (ARM) starts with a fixed rate for an initial period, then adjusts periodically based on a market index. The two structures spread interest-rate risk differently between you and the lender.

How a fixed-rate loan works

• Your interest rate — and therefore your principal-and-interest payment — never changes, whether the term is 30, 20, or 15 years.
• Shorter terms usually carry lower rates but higher monthly payments, since you repay the balance faster.
• The trade-off: predictability. You’re protected if rates rise, but you’d need to refinance to benefit if rates fall.

How an ARM works

ARMs are described with numbers like “5/6” — meaning the rate is fixed for the first 5 years, then adjusts every 6 months after that.

• Index + margin. After the fixed period, your rate resets to a published market index (a benchmark rate) plus a fixed margin set by your lender. The margin doesn’t change; the index moves with the market.
• Rate caps. ARMs include caps that limit how much the rate can move: an initial adjustment cap, a periodic cap (per adjustment), and a lifetime cap (the maximum over the loan’s life). Caps constrain — but don’t eliminate — payment increases.
• Initial rate. ARMs often start below comparable fixed rates, which lowers early payments.

How to think about the trade-off

• Fixed favors certainty and works well if you value a stable payment or expect to stay long-term.
• ARM front-loads a lower rate, which can suit someone who expects to move, sell, or refinance before the fixed period ends — but carries the risk that rates (and payments) rise afterward.
• Key questions: How long do you realistically expect to keep the loan? Could your budget absorb the payment if it hit the ARM’s caps? How stable is your income?