Fixed vs. variable: Which should you choose in today’s market?

Learn the critical differences between the two primary types of mortgages: fixed-rate and variable-rate

By Jesse Oberoi, CFA

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04 September 2023

If you’re in the market for a house, you’ll likely need a mortgage. And unless you’re sitting on a large pile of cash, this loan will be substantial.

But it’s not just the dollar amount of the mortgage you need to be concerned with. The type of loan you choose can significantly impact how much money you end up paying.

In this article, you’ll learn the critical differences between the two primary types of mortgages: fixed-rate and variable-rate. More importantly, read to the end to understand which type is likely the best option for you in today’s high-interest rate environment.

So, fixed or variable? Read on to find out.

What is a fixed-rate mortgage?

A fixed-rate mortgage is a home loan with an interest rate that remains constant throughout its life. Put another way, the payment that includes principal and interest will remain consistent for the life of the loan.

How much of that payment goes to principal and how much to interest will change as, over time, the principal amount is reduced. As the principal decreases, the amount of interest (not the rate) will decrease and you will slowly see more of your fixed payment go toward the principal.

This predictability offers borrowers straightforward budgeting but typically comes at a higher cost than a variable-rate mortgage.

What is a variable-rate mortgage?

A variable-rate mortgage, often called an adjustable-rate mortgage (ARM) or floating-rate mortgage, is a home loan with a fluctuating interest rate. The interest rate, and therefore the monthly payments, can change throughout the life of the loan.

These changes are usually driven by changing central bank monetary policy.

When the Fed raises interest rates, ARM rates tend to increase
When the Fed lowers interest rates, ARM rates tend to decrease

Fixed-rate vs. variable-rate mortgages

	Fixed-rate mortgage	Variable-rate mortgage
Interest rate	The interest rate remains constant throughout the term.	It has the potential to fluctuate throughout the term.
Monthly payments	Monthly payments remain constant.	Payments, like the interest rate, can change—up or down.
Long-term cost predictability	Payments are consistent and predictable.	Payments are less predictable than fixed-rate mortgages.
Starting interest rate	Fixed-rate mortgages typically have higher initial rates.	Variable rates usually start lower than fixed rates.
Best for	Low-rate environments.	Borrowers who believe rates will remain the same or lower.
Risk	Low risk because payments remain consistent.	Higher risk because interest rates can increase.
Interest rate cap	Not applicable.	Most variable-rate mortgages will include a cap on the rate of increases.
Suitability	For borrowers who desire stability.	For borrowers who are comfortable with more risk.

Fixed-rate mortgages: pros and cons

Pros

Simple: Fixed-rate mortgages are straightforward. They are easier to understand and offer the same payment amount month after month.
Predictable: Because your monthly payment doesn’t change, fixed-rate mortgages offer borrowers a predictable obligation each month.
Locked-in interest rate: Fixed-rate mortgages provide a secure rate that won’t change even if the Fed raises rates. This provides borrowers with interest rate security and peace of mind.
Potential savings: If rates rise over the loan's life, you could pay far less interest than a variable-rate loan.

Cons

Inflexible: Fixed-rate mortgages don’t allow you to take advantage of falling rates, unless you refinance.
Potentially more costly: If interest rates fall over the loan's life, you may pay more interest than an ARM.
Higher initial rates: Fixed-rate mortgages typically start with a higher interest rate than a comparable ARM.

Variable-rate mortgages: pros and cons

Pros

Short-term savings: If you intend to move or refinance within a few years, ARMs can save you money on interest. The reason has to do with timing. The shorter the term, the less time the Fed has to enact new rates. Therefore, the typically lower starting ARM interest rates can save you money during this time.
Potential longer-term savings: Your monthly payment will likely decrease if rates fall.
Lower initial rate: All else equal, variable-rate mortgages typically start with lower interest rates than their fixed-rate peers.

Cons

Complex: Unlike fixed rates, ARMs typically have more complex terms and conditions, such as how often rates can be adjusted.
Potential for higher costs: If the Fed hikes rates significantly, you could pay more each month than you would have had you selected a fixed rate.
Refinancing risk: If you decide in the future to refinance into a fixed term, you may find interest rates have risen considerably by that time. As a result, you’ll have to settle for a higher fixed rate.
Uncertainty: Your monthly obligation can change during the term. Depending on market conditions and the terms of your ARM, the monthly payment increase could be substantial.

Where are interest rates heading?

If this question could be answered with certainty, deciding which mortgage type to use would be easy.

Over the past year and a half, the Federal Reserve has implemented one of the most aggressive tightening campaigns in the organization's history. Since March 2022, rates have risen over 5% during 11 separate hikes.

The severity of the campaign is increasingly leading many market participants to predict a rate softening may soon be on the horizon.

In fact, as of the end of August 2023, 93% of interest rate traders believe the Fed will maintain current rates at the September 20 meeting.

In other words, the overwhelming majority expect a rate pause.

At the same time, Fed chair Jerome Powell has not ruled out further rate hikes. While price growth has dropped substantially from the 9.1% annual rate witnessed last summer, it remains at 3.2%—far higher than the Fed’s 2% target.

Powell reiterated at Jackson Hole last month that inflation “remains too high.” As a result, he said, the Fed is “prepared to raise rates further if appropriate.”

So, which type of mortgage should you choose?

Sadly, there’s no crystal ball to determine where interest rates will head in the United States. Choosing between a fixed or variable rate mortgage comes down to a few key questions.

Do you expect interest rates to continue rising and remain elevated for some time? If so, a fixed rate makes the most sense.
Can you handle fluctuating payments? If you can’t manage an increase in monthly mortgage payments, it’s probably best to stick to the predictability of a fixed rate.
Are you risk-averse? If you’re disinclined to take risks, you will likely feel more comfortable with a fixed rate, knowing it will remain constant.
How long do you plan to stay in the home? A shorter-term variable rate might make sense if you plan to move within a few years. But a fixed rate might be more appealing if you plan to remain in the house for an extended period.