Fixed or variable rate: how to think it through

How each one works

With a fixed-rate mortgage, the interest rate, and so your principal and interest payment, stays the same for the life of the loan. With an adjustable-rate mortgage (ARM), the starting rate is fixed for an initial period, which can last months or a few years, and then changes at regular intervals. Fixed rates dominate in the US: in early 2024, ARMs were only about 3.5% of outstanding mortgages, according to the FHFA.

The name tells you the schedule. In a 5/1 ARM, the first number is how many years the starting rate lasts, and the second is how often it changes afterward (here, once a year); a 5/6m ARM changes every six months. After the fixed period, your rate is an index plus a margin. The margin is set in your loan agreement and doesn’t change after closing; the index moves with the market, and your Loan Estimate tells you which one it is.

In the UK, you choose between a fixed deal and a variable rate, such as a tracker linked to the Bank of England’s Bank Rate. When a fixed deal ends, you move to the lender’s revert-to rate, formerly called the standard variable rate, unless you switch; under the 2026 Mortgage Charter, lenders that signed it let you lock in a new deal up to six months ahead.

What the caps allow

An ARM’s rate can’t move without limits. There are usually three caps: an initial cap on the first change, commonly two or five percentage points; a subsequent cap on each later change, commonly one or two points; and a lifetime cap on the total rise, most commonly five points above the starting rate.

Your Loan Estimate spells it all out. Page 1 answers whether the rate and payment can increase after closing, and the Projected Payments table shows the lowest and highest payments by year; page 2 has the Adjustable Interest Rate table, with the index, the margin and the caps. You also get advance notice: the first change must be announced 210 to 240 days before the first new payment is due, and later changes 60 to 120 days ahead.

Run the worst case

Here’s the math on a $300,000 loan over 30 years, with the formula the mortgage payment calculator uses; the rates are examples, not today’s offers. At a fixed 6.5%, you pay $1,896.20 a month for all 30 years. Say an ARM started a point lower, at 5.5%: $1,703.37 a month, $192.83 less. After five years, you’d still owe $277,381.81. If the rate then moved and stayed there for the remaining 25 years:

• Down one point, to 4.5%: $1,541.78 a month.
• Up two points, to 7.5%: $2,049.83, about $154 more than the fixed payment.
• Up to a five-point lifetime cap, 10.5%: $2,618.99, $915.62 more than where you started.

Traps to avoid

• Counting on refinancing. The CFPB is blunt: don’t assume you’ll be able to sell your home or refinance before the rate changes. Home values can fall, your income can change, and refinancing can cost about as much as your original closing costs.
• Assuming the rate can only fall. When the index drops, some ARMs lower your payment, but not all of them do: check for a rate floor.
• Paying points on an ARM. With an ARM, paying points often lowers your rate only until the end of the initial period, the CFPB’s handbook notes.
• Comparing the teaser rate alone. Compare Loan Estimates from several lenders, on the APR, which includes fees, as well as on the rate.

How to decide

A fixed rate buys certainty: the payment you sign for is the payment you’ll make, even if rates rise. Many ARMs start at a lower rate than fixed-rate loans, the CFPB notes, and in exchange you carry the risk of what comes after. Three questions help: How long will I keep this loan? Could I still pay the highest payment on my Loan Estimate? Would a rise keep me up at night? The CFPB’s own test is simple: if you couldn’t afford the higher payments on today’s income, you may want to consider another loan.