Fixed vs Variable Rate Mortgages: Which Suits You?

In the US the 30-year fixed dominates, and for a specific structural reason: it is government-supported through the secondary mortgage market, and it is unusually borrower-friendly compared with what most countries offer. Locking a rate for three decades with no penalty for refinancing later is not available in most housing markets worldwide.

How ARMs are actually structured

An ARM is described by two numbers, such as 5/1 or 7/6. The first is the years the initial rate holds. The second is how often it adjusts afterwards — annually for a 5/1, every six months for a 7/6.

The adjusted rate equals an index, now usually SOFR, plus a fixed margin. The margin is set at origination and never changes, so it is worth comparing between lenders as carefully as the initial rate.

Caps limit the movement, expressed as three numbers like 2/2/5: the first adjustment cannot exceed 2 percentage points, each subsequent adjustment cannot exceed 2, and the rate cannot rise more than 5 above the initial rate over the life of the loan. That lifetime cap is the number that defines your worst case, and you should calculate the payment at that rate before signing.

The arithmetic on the initial discount

ARMs price lower initially because the borrower absorbs future rate risk. The discount varies with the yield curve and has at times been slim enough to make ARMs poor value, and at other times wide enough to be compelling.

On a $400,000 loan, a half-point saving is roughly $120 a month, or about $7,200 across five years of a 5/1 ARM. Worth having, but not transformative — and it must be weighed against the possibility of the rate rising afterwards.

When an ARM genuinely makes sense

The clearest case is a known, short horizon. Military families expecting reassignment, physicians in a fixed-length residency, anyone confident they will sell or move within the fixed period. If you are gone before the first adjustment, you captured the discount and never carried the risk.

The second case is a borrower who could comfortably absorb the capped worst case. If the payment at the lifetime cap is still manageable, the risk is priced in and tolerable.

The weak case is 'I will refinance before it adjusts.' That assumes future rates and your future creditworthiness will both cooperate. Borrowers who made that assumption in 2021 and needed to refinance in 2023 discovered how badly it can go.

The case for fixed

Fixed rates convert your largest monthly obligation into a known constant for thirty years, which has value beyond the interest arithmetic. It makes household budgeting possible over long horizons and removes an entire category of anxiety.

Inflation also works in your favour: you repay a fixed nominal amount with money that is worth progressively less, while wages generally rise. A payment that consumed a third of your income in year one may consume a fifth by year fifteen without you doing anything.

Term length matters more than most people think

A 15-year fixed carries a lower rate than a 30-year and dramatically less total interest, at the cost of a considerably higher payment. On a $400,000 loan the total interest difference over the life of the loan is frequently well over $150,000.

A middle path some borrowers prefer: take the 30-year for payment flexibility, then make voluntary extra principal payments. You capture much of the interest saving while retaining the option to pay only the required amount in a difficult month. Confirm there is no prepayment penalty, though these are rare on conforming US loans.

How to decide

Calculate three payments: the fixed-rate payment, the ARM's initial payment, and the ARM's payment at its lifetime cap. If the capped figure would strain your household, take the fixed rate regardless of the initial saving.