Almost every home loan is either fixed-rate or adjustable-rate, and the choice shapes your payment for decades. A fixed-rate mortgage keeps the same interest rate for the entire term, while an adjustable-rate mortgage (ARM) starts with a lower fixed rate that later resets on a schedule. Knowing how each behaves helps you match the loan to how long you plan to stay and how much payment risk you can stomach.

How a fixed-rate loan works

With a fixed-rate mortgage, the interest rate is set at closing and never changes, so the principal-and-interest portion of your payment is identical in month one and month 360. This predictability makes budgeting simple and protects you completely if market rates rise. The trade-off is that fixed rates usually start higher than the introductory rate on a comparable ARM. If rates fall sharply later, the only way to capture the lower rate is to refinance into a new loan.

How an ARM is structured

An ARM is described by two numbers, such as 5/6 or 7/1, where the first is the years the intro rate stays fixed and the second is how often it adjusts afterward. After the intro period, the rate resets to an index (commonly SOFR) plus a fixed margin set by the lender. Caps limit how much the rate can move at the first adjustment, at each later adjustment, and over the life of the loan. Because the lender is not locking a rate for 30 years, the starting rate is typically lower than a fixed loan.

Weighing the trade-offs

The core question is how long you will keep the loan versus how long the intro rate lasts. If you expect to sell or refinance before an ARM's fixed period ends, the lower intro rate can save real money with little exposure to resets. If you plan to stay long term, a fixed rate removes the risk that payments jump when the intro period expires. Your tolerance for payment uncertainty matters as much as the math, because a reset can raise the payment by hundreds of dollars.

Reading the ARM fine print

Never judge an ARM by its teaser rate alone; look at the margin, the index, and all three caps, because those determine the worst-case payment. The initial cap and lifetime cap tell you how high the rate could climb after the fixed period ends. Ask the lender to show the fully indexed rate, which is the current index plus the margin, to see what the rate would be if it adjusted today. Confirm whether the loan has a prepayment penalty, since some ARMs discourage the early refinance that makes them attractive.

Suppose a 7/6 ARM starts at 6.0% while a 30-year fixed is 6.75% on a $400,000 loan. The ARM payment is about $2,398 versus $2,594 fixed, saving roughly $196 a month for the first seven years. If you know you will move within seven years, that is nearly $16,500 saved with no reset risk. Stay longer, though, and the payment could climb well past the fixed amount when the rate adjusts.

Key takeaways

  • A fixed rate never changes; an ARM offers a lower intro rate that resets on a set schedule.
  • ARM names like 5/6 mean the rate is fixed for five years, then adjusts every six months.
  • Caps limit how far an ARM rate can rise at each reset and over the life of the loan.
  • ARMs favor short holding periods; fixed loans favor staying put and hating surprises.
  • Judge an ARM by its margin, index, and caps, not just the introductory rate.

Common mistakes

FAQ

Can I refinance an ARM into a fixed loan later?

Yes, refinancing an ARM into a fixed-rate mortgage is common, but it depends on qualifying again and on where rates sit at that time. There is no guarantee the fixed rate available then will be affordable.

What index do most ARMs use now?

Most new ARMs are tied to SOFR (the Secured Overnight Financing Rate), which replaced LIBOR. Your rate after the intro period equals that index plus the lender's fixed margin.