Certainty and predictability with fixed rates
A fixed-rate mortgage locks the interest rate for the entire loan term (typically 15 or 30 years). The borrower pays the same rate in year one and year 30. The monthly payment never changes (except for property tax or insurance increases). This predictability makes budgeting stable and removes interest-rate risk.
Fixed rates appeal to borrowers planning to stay in the home long-term, those on tight budgets, or those who believe rates will rise. Fixed rates are typically higher than the initial ARM rate because the lender bears the interest-rate risk. A fixed 7% mortgage carries more lender cost than an ARM at 5% for the first five years.
ARM flexibility and rate reset risk
Adjustable-rate mortgages (ARMs) offer a low initial rate (teaser rate) that lasts 3-10 years, then adjust periodically (annually or every five years) based on a market index plus a lender margin. A 5/1 ARM has five years fixed, then adjusts annually. The rate caps limit how much it can increase (typically 2% per adjustment period, 5-6% lifetime), but substantial increases are still possible.
ARMs make sense for buyers planning to sell or refinance before the rate adjusts, or those betting rates will stay flat or decline. Someone borrowing $400,000 on a 5/1 ARM at 5% versus 7% fixed saves roughly $500 monthly for five years ($30,000 total). If rates rise to 8% at adjustment, the savings evaporate and the payment jumps. ARM borrowers need financial reserves to absorb payment increases.