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Fixed- vs. adjustable-rate mortgages

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Fixed-rate loans are more common and borrowers like their predictability. But ARMs could save you money if you'll only have the loan for a short time.

The pros and cons of fixed-rate mortgages

Fixed-rate mortgages are by far the most popular type of mortgagein the United States. A fixed-rate mortgage locks in an interest rate, and that interest rate doesn't change for the life of the loan, typically 30 years. The primary advantage with a fixed-rate mortgage is predictability. Your monthly mortgage payments are fairly stable because of that steady interest rate, and you won't be affected by a rise in interest rates.

However, the interest rates offered for fixed-rate loans are usually higher than for adjustable-rate mortgages, which means a higher monthly payment than with an adjustable rate.

The pros and cons of adjustable-rate mortgages

Adjustable-rate mortgages (ARMs) are home loans whose interest rates fluctuate after an initial stable period. The length of that period depends on the type of loan you get. A 5/1 ARM, which is the most popular,2 has a constant interest rate for the first five years of the loan (that's the “5"), and it adjusts (resets) every one year (that's the “1"). Other ARMs are 3/1, 7/1, and 10/1, which adjust after three, seven, and ten years, respectively. The adjusted interest rates are based on a particular index, which your lender can explain.

ARMs generally have attractive “teaser" interest rates3 during the initial steady period, which means your mortgage payments will be lower with an ARM to start off than with a fixed-rate mortgage. But if interest rates are higher when the rate resets, your payments will jump – and then the next year, it could reset to an even higher rate, and so on. By the end of the loan, you could be paying significantly more than you did early on, depending on how the Fed adjusts interest rates in an ever-changing economy.

Examples of fixed-rate loans versus ARMs

Let's say you borrowed $200,000 with a 30-year, fixed-rate loan at 4% interest. According to the mortgage calculator, your principal and interest would come to $955/month.

If, instead, you chose a 5/1 ARM and a teaser rate of 3.5%, you would pay $898/month for principal and interest on the same loan amount, about $50 less than the fixed-rate scenario. But let's assume when that rate resets after five years, the interest rates were higher. If the rates rose by one percentage point (from 3.5% to 4.5%), the 5/1 ARM would adjust to a new monthly payment of $1,013. If rates kept going up, your payment would continue to rise too. You can see the effects of different interest rates and rate adjustments with our ARM calculator.

It's important to know that with an ARM, there is usually a limit to how high your interest rate can rise. These limits are reflected in the loan's rate caps.4 There are three types of caps:

  • The amount your interest rate can change (either up or down) the first time it adjusts, often two percentage points.
  • How much it can adjust in each period that follows, also often two percentage points.
  • How much it can shift in total over the life of the loan, commonly five percentage points.

To use the example from above, if mortgage interest rates were to rise significantly, your interest rate could potentially rise (in a series of steps) from 3.5% to 8.5%. This would leave you with a monthly payment of $1,538 — more than 60% higher than the monthly payment you started out at.

Which type of mortgage is right for you?

So, should you choose a fixed-rate loan or an ARM? That largely depends on how long you plan to have your loan5 and your ability to cover a higher monthly payment if the interest rates go up.

If you're planning to stay in your house for more than five years and you can lock into a low rate, a fixed-rate loan would be a solid choice.

On the other hand, an ARM could be more sensible if you plan to pay off the loan or move before the rate resets. For example, you might be expecting an inheritance or other windfall in the next couple of years, or perhaps you're planning to relocate within the next five years. In those cases, you'd be done with the loan before the higher rates kick in.

Refinancing your fixed-rate mortgage or ARM

If you want to change your loan type — or lock into a new rate on your fixed-rate mortgage — there is always the option to refinance. When you refinance your loan, you get a new loan (with more favorable terms for you), use the principle or pay off your old loan, and then start making mortgage payments on your new loan. Keep in mind that it does cost money to refinance, and you don't want to spend more than you'll end up saving; our calculator can help you determine whether it makes financial sense to do so.

It's not uncommon for holders of ARM loans to refinance to a fixed rate when the first reset nears. This makes sense when interest rates are rising. After all, if you stay in an ARM, your monthly payment will rise, too.

If you're in a fixed-rate mortgage, and interest rates are falling, you can refinance into an ARM. Between the overall lower interest rates and the ARM's initial lower interest rate, you could see a significant drop in your monthly payment. Just remember that if you anticipate you'll still be paying off the loan after the initial stable period, you might face higher interest rates and thus higher payments down the road.

In the end, your individual situation should be the deciding factor in the type of loan you select. Just like when finding the perfect house, the best one fits you, your family, and your life.

Ready to take the next step? Explore mortgage loan options from Synovus and contact a mortgage lender near you.

This content is general in nature and does not constitute legal, tax, accounting, financial or investment advice. You are encouraged to consult with competent legal, tax, accounting, financial or investment professionals based on your specific circumstances. We do not make any warranties as to accuracy or completeness of this information, do not endorse any third-party companies, products, or services described here, and take no liability for your use of this information.