Key takeaways
- Fixed-rate mortgages keep principal and interest the same for the full term.
- A 5/6 ARM is fixed for five years, then adjusts every six months based on an index plus a margin.
- Caps such as 2/1/5 limit how much an ARM's rate can rise at each adjustment and over the loan's life.
- In our hypothetical $350,000 example, the ARM saves about $10,300 over five years but could reach about $3,176 a month at its cap.
- Choose an ARM only if you could afford the lifetime-cap payment or have a firm plan to move before it adjusts.
Choosing between a fixed-rate mortgage and an adjustable-rate mortgage (ARM) is one of the few home-loan decisions that can change your monthly payment by hundreds of dollars years after you close. A fixed rate buys certainty: the principal-and-interest payment never changes. An ARM usually starts with a lower rate, but after the introductory period the rate can move up or down with the market. Neither is automatically better. The right choice depends on how long you expect to keep the loan, how much payment risk your budget can absorb and how you would handle a worst-case adjustment. This guide breaks down how each loan works, runs the numbers on a $350,000 example and gives you a framework for deciding.
How a fixed-rate mortgage works
With a fixed-rate mortgage, the interest rate is set at closing and stays the same for the entire term, most commonly 30 or 15 years. Your principal-and-interest payment is identical every month. Your total payment can still change if property taxes or homeowners insurance held in escrow go up, but the loan itself does not.
- 30-year fixed: lowest fixed payment, most total interest over time.
- 15-year fixed: higher payment, typically a lower rate and far less total interest.
- Refinance option: if market rates fall meaningfully, you can refinance, though that means new closing costs and qualifying again.
How an adjustable-rate mortgage works
Most ARMs today are hybrid ARMs. The rate is fixed for an initial period, then adjusts on a schedule. The name tells you the structure: a 5/6 ARM is fixed for five years, then adjusts every six months. A 7/6 or 10/6 ARM works the same way with a longer fixed period. Older-style 5/1 ARMs adjust once a year after the fixed period.
Index, margin and caps
Once the fixed period ends, your new rate is calculated as index + margin, limited by caps:
- Index: a market benchmark. Many newer ARMs use the Secured Overnight Financing Rate (SOFR), which replaced LIBOR.
- Margin: a fixed number of percentage points the lender adds, set in your loan documents and unchanged for the life of the loan.
- Initial adjustment cap: the most the rate can change at the first adjustment.
- Periodic cap: the most it can change at each later adjustment.
- Lifetime cap: the most it can ever rise above the starting rate.
Caps are written as three numbers. A common 5/6 ARM structure is 2/1/5: up to 2 points at the first adjustment, up to 1 point at each six-month adjustment after that, and no more than 5 points above the start rate over the life of the loan. Lenders must give you the CFPB's Consumer Handbook on Adjustable-Rate Mortgages and loan-specific disclosures, so you can see your exact index, margin and caps before committing.
Worked example: $350,000 fixed vs. 5/6 ARM
The figures below use hypothetical rates chosen only to illustrate the trade-off; they are not current market quotes. Both loans are $350,000 over 30 years. The fixed loan is at 6.75%. The 5/6 ARM starts at 6.00% with 2/1/5 caps. Payments shown are principal and interest only.
| Measure | 30-year fixed at 6.75% | 5/6 ARM starting at 6.00% |
|---|---|---|
| Monthly payment, years 1–5 | $2,270.09 | $2,098.43 |
| Monthly difference | — | $171.66 lower |
| Payment savings over 5 years | — | About $10,300 |
| Balance after 5 years | About $328,565 | About $325,690 |
| Payment if rate rises 2 points at month 61 (8.00%) | $2,270.09 (unchanged) | $2,513.73 |
| Payment at lifetime cap (11.00%, reachable by month 79) | $2,270.09 (unchanged) | About $3,176 |
Two things stand out. First, the ARM's early advantage is real: about $10,300 less in payments over five years, and because more of each payment goes to principal at the lower rate, the ARM balance is also about $2,875 lower at the five-year mark. Second, the downside is also real. If the rate rose by the maximum allowed at the first adjustment, the payment would jump about $415 from the ARM's starting payment and run about $244 a month above the fixed loan. At that gap, the five-year savings would be used up in roughly three and a half years. In the worst case, the payment could reach about $3,176, more than $900 above the fixed payment.
Of course, rates could also stay flat or fall, in which case the ARM could remain cheaper. The point of the exercise is not to predict rates; it is to make sure you could live with the worst case.
Fixed vs. ARM: side-by-side comparison
| Factor | Fixed-rate mortgage | Adjustable-rate mortgage |
|---|---|---|
| Starting rate | Typically higher | Typically lower during the fixed period |
| Payment predictability | Principal and interest never change | Can rise or fall after the intro period |
| Benefit if rates fall | Only through refinancing | Rate can adjust down automatically, subject to floors |
| Risk if rates rise | None on the loan itself | Payment increases up to the caps |
| Best for | Long-term owners and tight budgets | Shorter expected ownership or strong income growth and reserves |
Who should choose which?
A fixed rate usually fits if you…
- Plan to stay in the home longer than the ARM's fixed period.
- Have a budget where a $300 to $900 payment increase would cause real strain.
- Are a first-time buyer still building an emergency fund.
- Value predictability more than the potential to save.
An ARM may fit if you…
- Have a realistic plan to sell or move before the first adjustment, such as a known job relocation.
- Could comfortably afford the payment at the lifetime cap.
- Hold solid cash reserves and stable or rising income.
- Would use the early savings deliberately, such as paying extra principal.
Other ways to lower your rate
An ARM is not the only route to a lower starting payment. Before choosing one purely to save money, compare these alternatives on a fixed-rate loan:
- Discount points: paying upfront, typically 1% of the loan amount per point, to reduce the rate for the life of the loan. Points pay off only if you keep the loan long enough to pass the break-even month.
- Temporary buydowns: such as a 2-1 buydown, often funded by a seller, which lowers the payment for the first one or two years. You must still qualify at the full note rate.
- A 15-year fixed: a higher payment but usually a lower rate and dramatically less total interest.
Questions to ask your lender
- What is the index, the margin and the fully indexed rate today?
- What are the initial, periodic and lifetime caps, and is there a rate floor?
- What would my payment be at the first-adjustment cap and at the lifetime cap?
- Are there prepayment penalties or conversion options?
- How do the Loan Estimates compare on points, lender fees and APR for the fixed and ARM options?
The Loan Estimate, which lenders must provide within three business days of your application, shows projected payment ranges for ARMs, making side-by-side comparison easier. Gathering your paperwork early speeds this up; see our loan documents checklist. If you are buying for the first time, our FHA loan guide explains low-down-payment options, which are available in both fixed and adjustable versions. Your credit score also shapes the rate on either type, as covered in how credit scores affect loan rates.
How Lending Buddy can help
Lending Buddy is a free connection service, not a mortgage lender. Through our home loans section, you can share your goals once and may be connected with mortgage partners offering fixed-rate and adjustable-rate programs. Partners set all rates, fees and terms and make every lending decision. Lending Buddy does not recommend a specific loan type, so use the stress test above to decide which fits your budget. To learn how the process works, visit how it works, or start your request when you are ready to compare.
The bottom line
A fixed-rate mortgage trades a somewhat higher starting rate for a payment that never changes, which is why it remains the default choice for most long-term homeowners. An ARM can save meaningful money in the early years, about $10,300 over five years in our hypothetical example, but only makes sense if you understand the index, margin and caps and could afford the payment at the cap. Decide based on how long you will keep the loan and how much risk your budget can carry, not on the lowest advertised rate.
Frequently Asked Questions
What does 5/6 ARM mean?
A 5/6 ARM has a fixed interest rate for the first five years. After that, the rate adjusts every six months based on a market index, often SOFR, plus a fixed margin set in your loan documents. Caps limit how much the rate can change at the first adjustment, at each later adjustment and over the life of the loan.
Is an adjustable-rate mortgage risky?
An ARM carries payment risk because the rate can rise after the fixed period, up to the limits set by its caps. That risk is manageable if you can comfortably afford the payment at the lifetime cap or plan to sell before the first adjustment. It is riskier for tight budgets or buyers who expect to keep the loan long term.
Can I switch from an ARM to a fixed rate later?
Usually by refinancing into a fixed-rate loan, which requires qualifying again and paying closing costs. A few ARMs include a conversion option for a fee. Because refinancing depends on future rates, your income, credit and home value, it is safer not to rely on it as your only plan before the rate adjusts.
Which is better for a first-time homebuyer?
Many first-time buyers prefer a fixed rate because it keeps the payment predictable while they build savings and adjust to homeownership costs. An ARM can make sense if you expect to move within the fixed period and could afford the higher payment if rates rose. Compare Loan Estimates for both before deciding.
