Fixed or Variable Rate Mortgage: Which Is Better Right Now?

The average national mortgage rates vary by location and your own rate will depend heavily on your credit score. As of Sept, 29, 2022, Investopedia's mortgage lender survey reported that mortgage rates were 6.99% for a 30-year fixed, 6.50% for a 15-year fixed, and 6.36% for the first five years on a 5/6 adjustable-rate mortgage (ARM).

Your mortgage rate will play a key role in what type of mortgage your may get. The first step in deciding whether a fixed-rate mortgage or an ARM is the best choice in today's market is get information from several lenders. Find out what rate you qualify for and what loan terms you may get with your credit score, income, debts, down payment, and the monthly payment you can afford.

Once you know what rate and term you can receive, you'll need to choose between a fixed-rate mortgage and an ARM.

Fixed vs. ARM: Monthly Payment Difference

For every $100,000 you borrow, here’s what you may pay per month for different mortgage types based on the average interest rates of 6.99% for a 30-year fixed, 6.50% for a 15-year fixed, and 6.36% for the first five years on a 5/6 adjustable-rate mortgage (ARM), which were the average interest rates as of Sept. 29, 2022.

• 30-year, fixed rate mortgage: $913
• 15-year, fixed rate mortgage: $1,120
• 5/6 adjustable rate mortgage: $872 for the first 60 months

Looking only at the monthly payment, the adjustable rate mortgage seems like it might be the better choice, and you could save a significant amount in the long-term, depending on how the rates adjust.

But you must consider if the difference is worth the additional risks associated with an ARM, such as the risk interest rates will rise. If you plan to move within the initial 5-year term or expect to refinance if rates move lower, the risk may be worth it.

Types of Adjustable-Rate Mortgage

The most popular types of ARMs are hybrid ARMs, which include 5/6, 3/1, 7/1, and 10/1 ARMs.

A 5/6 ARM, for example, has a fixed interest rate for the first five years, called the introductory period. After that, the interest rate adjusts twice a year (every six months) for the rest of the loan term. The longer the initial period, the smaller the difference will be between the interest rate of the ARM and the interest rate of the fixed-rate mortgage.

In the U.S., the interest rate for most ARMs is based on the U.S. Treasury rate. Treasury rates have been very low in recent years, but they have been rising amid tightening monetary policy. The Federal Reserve has raised interest rates four times in 2022 as of September 2022 by increments of 0.25%, 0.50%, 0.75%, and 0.75%.

Risk Tolerance and Future Plans 

When you take out a fixed-rate mortgage, you know before you sign your closing papers exactly how much your mortgage payment will be each and every month for as long as you have the mortgage. Many people value this predictability.

ARMs are subject to interest-rate risk, or the possibility that the interest rate will change. After the initial term, the interest rate for an ARM adjusts to reflect current market conditions.

You can also estimate what an ARM’s interest rate will be when it resets after the introductory period. The details of a particular ARM – or the interest rate cap structure – tell you how high your monthly payment could go. A 5/1 ARM, for example, might have a cap structure of 2-2-5, meaning that in year six (after the five-year introductory period expires), the interest rate can increase by 2%, in subsequent years the interest rate can increase by an additional 2% per year, and the total interest rate increase can never total more than 5% over the life of the loan.

Even with the cap, consider if you can manage the extra cost if interest rates rise to their maximum. Whether your rate ever adjusts to its maximum depends on the ARM’s index rate. If your ARM is indexed to the one-year Treasury rate and that rate is the same in year six as it was in year one, then your interest rate will not increase in year six. However, if the Treasury rate increases by 3%, your interest rate won’t increase by more than 2% in year six because of the cap.

If you are considering an ARMs, factor in the likelihood that these events will occur:

• You will sell the home before the loan resets.
• Your income will increase before the loan resets.
• You'll be able to refinance before the loan resets.
• Interest rates will remain stable or decline, giving them a rate that is similar to the introductory rate when the loan resets.

FHA ARMs

The Federal Housing Administration (FHA) guarantees adjustable-rate mortgages, allowing lenders to offer them to borrowers who need more lenient requirements to qualify. The FHA offers 1-year ARMs and 3-, 5-, 7- and 10-year hybrid ARMs.

The interest rate on the 1-year and 3-year versions cannot increase by more than 1% per year after the introductory period or by more than 5% over the life of the loan. The interest rate on the 5-, 7-, and 10-year ARMs cannot increase by more than 2% per year after the introductory period, and the lifetime cap is 6%.

Like all FHA mortgages, while an FHA ARM may have more lenient qualifications, it requires borrowers to pay an upfront mortgage insurance premium of 1.75% of the loan amount (which is usually rolled into the loan, and you’ll pay interest on it as a result).

If, for instance, you make the FHA’s minimum required down payment of 3.5% and take out a 30-year loan, you’ll pay 0.85% of the outstanding loan balance each year in mortgage insurance until you pay the loan in full. Divide this by 12 and added to your monthly payment. On a $200,000 loan, the upfront premium would cost you $3,500, and the monthly mortgage insurance premiums would cost you about $142 a month for the first year and gradually decline after that.

Choosing Between a Fixed-Rate Loan and an ARM

Once you understand the difference between fixed-rate mortgages and ARMs, you'll need to factor in your personal financial situation to determine which mortgage is best for you right now.

Sean O. McGeehan, a loan officer in Homer Glen, Ill., near Chicago says many of his clients prefer fixed rates. "They are traditionally first-time homebuyers that are buying a condo or single-family home and don’t know their future plans,” he said. “If they end up having children and need to stay there in the long term, a fixed rate will give them certainty and stability in their mortgage payments.”

Since interest rates are rising in today’s market, most homebuyers aren’t interested in taking the risk on an ARM.

Lauren Abrams, a mortgage advisor with Absolute Mortgage Banking in San Ramon, Calif. said that due to the current low interest rate environment, the 30-year fixed loan option 90% have been popular for first-time homebuyers. However, she said, buyers need to consider their long-term plans.

“In most cases buyers don’t know or can’t predict what those plans will be,” Abrams said. “Clients sometimes insist that this is just a starter home and [they] won’t be in it for more than three to five years.” This time frame can vary from as short as one year, such as if there is a divorce, job transfer, marriage or children, to more than 10 years.

Borrowers who think they will be in the home for a shorter time and want to use an ARM could mitigate their risk by putting their monthly savings in an interest-bearing account to cover a potentially higher future payment, if they’re still in the home when the rate adjusts.

Wealthy clients and investors who have a plan for how long they will carry the mortgage and can afford potentially higher payments later on are more likely to see the appeal of an ARM and more likely to benefit from its introductory rate.

The Bottom Line

Approximately 10% of borrowers chose ARMs the week ending Sept. 23, 2022, according to data from the Mortgage Bankers Association.

If you want to use an ARM because its lower interest rate may help you qualify for financing to purchase a more expensive property, consider whether the difference in the quality of property you can get with the ARM makes the interest-rate risk worthwhile. For many borrowers in this rising interest rate market, a fixed rate may be more prudent.