The Short Version
A fixed-rate mortgage locks in the same interest rate for the entire loan term, so the principal + interest payment never changes. An adjustable-rate mortgage (ARM) starts with a lower introductory rate for a fixed period, then periodically resets based on a market index, meaning the payment can rise (or fall) afterward. ARMs trade predictability for a lower starting rate.
Explain It Like I'm 10
Imagine two ways to agree on your weekly allowance for the next year. One way locks in exactly $20/week no matter what happens (fixed-rate) — predictable, easy to plan around. The other way starts you off at a lower $15/week for a while, but after six months, it can change based on how the family's finances are doing generally (adjustable-rate) — maybe it drops further, maybe it jumps to $25. The second option is cheaper at first, but you're taking on the risk that it could get more expensive later.
Step-by-Step Example
- 1 Fixed-rate mortgage: 6.0% for all 30 years. Monthly payment stays the same from year 1 to year 30.
- 2 5/1 ARM on an identical loan: starts at 5.25% for the first 5 years — a noticeably lower payment than the fixed option.
- 3 After year 5, the ARM's rate adjusts annually based on a market index plus a set margin.
- 4 If market rates have risen by then, the ARM's rate might reset to 7.5% — a meaningfully higher payment than either the original ARM rate or the fixed-rate option.
- 5 A borrower who planned to sell or refinance well before year 5 could have benefited from the ARM's lower initial rate; one who kept the loan long-term took on real risk that didn't pay off.
Quick Recap
- ✓ Fixed-rate: payment predictability for the full loan term, generally at a somewhat higher starting rate than an ARM.
- ✓ ARM (e.g., a '5/1 ARM'): rate is fixed for the first 5 years, then adjusts annually afterward based on a benchmark rate plus a margin.
- ✓ ARMs can make sense if you're confident you'll sell or refinance before the adjustable period begins.
- ✓ ARMs carry real risk if rates rise sharply by the time the fixed period ends — the payment can increase meaningfully with little warning.