ARM vs fixed-rate mortgage
ARM vs Fixed Mortgage
Adjustable-rate mortgages start cheaper than fixed — sometimes by a lot. The question is whether you'll be out of the house before the rate resets.
ARM (e.g. 7/1)
Lower initial rate that can adjust after a fixed teaser period.
Fixed-rate mortgage
Rate locked for the full 15- or 30-year term.
At a glance
| ARM (e.g. 7/1) | Fixed-rate mortgage | |
|---|---|---|
| Initial rate vs 30-year fixed | Typically 0.5–1.5% lower for first period | Industry benchmark |
| Rate after teaser period | Resets annually based on index + margin | Doesn't change |
| Lifetime cap | Usually 5–6 percentage points above start rate | N/A — rate is fixed |
| Predictability | Predictable for teaser period only | Fully predictable |
| Best when… | You'll sell or refi within the teaser window | You'll hold the loan long-term |
| Worst when… | Rates rise and you can't sell or refi | Rates fall after you lock in (refinance solves this) |
Pick ARM (e.g. 7/1)
Pick an ARM if there's a strong probability you'll be out of the house — sold, refinanced, or paid off — before the teaser period ends. Common cases: military relocation, residency/fellowship before settling, planned upgrade in 5–7 years, or jumbo loans where ARM pricing is unusually attractive.
Pick Fixed-rate mortgage
Pick a fixed-rate mortgage if there's any uncertainty about how long you'll hold the loan, if your budget would crack under a 200–400 bps rate jump, or if you're at retirement age and value payment certainty over rate optimization. The 'I'll just refi if rates spike' plan only works when refinancing is actually available — and it isn't always.
How an ARM actually works
A 7/1 ARM is fixed for 7 years, then resets annually thereafter. The reset is calculated as `index + margin`: the index is a market rate (commonly SOFR or Treasury), the margin is fixed at origination (typical 2.25–2.75%). If SOFR is 4.5% and your margin is 2.5%, your new rate is 7.0% — regardless of what your starting rate was.
Three caps protect you: an initial cap (max change at first reset, often 5%), a periodic cap (max change at each subsequent reset, typically 2%), and a lifetime cap (typically 5–6 points above start). The caps make worst-case modeling possible — but the worst case on a 5/1 ARM that started at 5% can still be 10–11% in year 6.
The historical track record
ARMs got a reputation in 2007–2010 for blowing up borrowers, but most of those were predatory products (negative-amortization, 2/28 teaser-then-jump structures, no-doc underwriting). Modern ARMs sold by mainstream lenders are tightly regulated post-Dodd-Frank: full underwriting, qualification at the fully-indexed rate, mandatory rate-cap disclosures.
That said, the math of ARM rate shock hasn't changed. If you take a 5/1 ARM at 5% and rates climb to 7% by year 6, your monthly payment on a $400K loan jumps roughly $475/month. If your income hasn't grown enough to absorb that, you're facing the same forced-sale or default scenarios as 2008-era borrowers.
When ARMs are a smart bet
Short expected hold. If your job, family, or military situation makes a sale or relocation likely within the teaser period, an ARM saves real money — often 0.5–1% per year on the rate, which on a $500K loan is $2,500–$5,000/year.
Aggressive principal paydown. If you plan to throw extra principal at the loan and pay it off well before the teaser ends, the ARM rate advantage compounds.
Jumbo loans where ARM pricing is unusually generous. Jumbo ARMs (loans above the conforming limit) sometimes price 1.5%+ below jumbo fixed. The rate gap can justify the reset risk if you have liquidity to refinance or sell quickly.
Stress test before you sign
Before taking any ARM, run the numbers at the lifetime cap rate, not the teaser. If the maximum-possible monthly payment would still fit in your budget with 10–20% headroom, the ARM is genuinely a calculated bet. If it would crack you, the rate discount isn't a discount — it's leverage you can't safely carry.