How to use the fixed vs variable mortgage calculator
The example compares a $400,000 loan over 30 years: a fixed rate of 6.5% against a 5 years (5/1 ARM) at 5.75%, kept for 7 years.
- The loan. The amount and term are the same for both options.
- The two offers. Use the fixed rate and the ARM’s initial rate from lender quotes, and choose the initial fixed period.
- Your horizon. How long you expect to keep the loan before selling or refinancing. This is the most important input, because the ARM’s advantage is front-loaded.
- Index, margin and your scenario. The loan estimate names the index and margin. The expected yearly change is your view of rates: try a fall, flat and a rise.
- Caps. Enter the three caps from the loan terms. They set the worst case.
The chart shows the payment each year for the fixed loan, the ARM in your scenario and the ARM in the worst case the caps permit.
How the ARM is modeled
During the initial period the ARM works like any fixed loan. At each yearly reset the rate is recalculated and the payment is re-amortized over the months that remain:
New rate = Target, limited to Old rate ± Cap, not below the Margin, not above Initial rate + Lifetime cap
New payment = Balance × i (1 + i)m ÷ [(1 + i)m − 1]The index in year y is today's index plus y × the expected yearly change. The cap is the initial cap at the first reset and the periodic cap after that. i is the new rate ÷ 12 and m the number of payments left.
The comparison then adds up interest on both loans:
Break-even index change = the yearly change at which both loans cost the same over the horizonInterest is the true cost of borrowing: principal repaid is your own money moved into the house, so it is not counted.
A worked example
The fixed loan costs $2,528.27 a month for 30 years. The ARM starts at $2,334.29, $193.98 less, for the first five years.
The index is 4% today and the margin 2.75%, so the fully indexed rate is 6.75%. If the index stays flat, the first reset moves the rate to 6.75% and the payment to $2,563.62, slightly above the fixed payment.
Over 7 years, the ARM charges $160,427 of interest against $174,040 for the fixed loan: a saving of $13,613. The ARM stays cheaper over the horizon unless the index rises by more than about 0.45 points a year.
If the rate instead climbs as fast as the 2/2/5 caps allow, the payment reaches $3,545.13, and over 7 years the ARM would cost $1,154 more than the fixed loan.
Falling, flat and rising rates
The same two offers give very different results depending on what the index does. With the example’s 7 years horizon:
| Index scenario | ARM payment after year 5 | ARM saving over 7 years | ARM saving over 30 years |
|---|---|---|---|
| Falling 0.5 points a year | $2,010.11 | $33,896 | $244,332 |
| Flat | $2,563.62 | $13,613 | $1,035 |
| Rising 0.5 points a year | $2,802.64 | -$1,154 | -$279,198 |
Two things stand out. First, over seven years the range is narrow on the downside: even with steadily rising rates, the ARM costs only $1,154 more in interest, because five cheap years offset two expensive ones. The caps limit how fast the rate can climb, which protects a short-horizon borrower.
Second, over the full term the outcomes spread enormously: the ARM costs $279,198 more if rates keep rising, and saves $244,332 if they fall. Holding an ARM for decades is a bet on interest rates; holding one for the fixed period is not.
The horizon decides most of the answer
An ARM’s discount is concentrated in its first years, and its risk comes later. That makes the time you keep the loan more important than any forecast:
| Example change | ARM saving over the horizon | Break-even index change |
|---|---|---|
| 5/1 ARM kept 7 years (the example) | $13,613 | 0.45 points a year |
| 3/1 ARM kept 7 years | $5,691 | 0.08 points a year |
| 7/1 ARM kept 7 years | $21,025 | ARM cheaper in every case |
| 5/1 ARM kept 15 years | $7,930 | 0.02 points a year |
When the fixed period covers your whole horizon, as with the 7/1 here, the ARM cannot lose. A shorter fixed period, or a longer stay, makes it fragile. Kept for 15 years, the 5/1 ARM wins only if the index is flat or falling; a rise of a quarter point a year turns the result into an extra cost of $76,506. Longer fixed periods usually carry a smaller discount.
Reading the result
- Plan for the worst-case payment, not the expected one. If $3,545.13 a month would strain your budget, the ARM’s savings are not worth the risk, however likely the flat scenario looks.
- Compare margins as well as initial rates. A low teaser rate with a high margin can cost more after the first reset than a slightly higher start with a lower margin.
- Refinancing is an exit, not a guarantee. It depends on your income, credit, home value and rates at the time of the reset.
- A fixed rate keeps an option open. If rates fall a lot, a fixed-rate borrower can usually refinance; the refinance calculator tests whether that pays.
What this calculator does not include
- Rate paths that zigzag. The scenario moves the index by the same amount every year. Real rates rise and fall unevenly; try several values to see the range.
- Rounding and lookback rules. Many ARMs round the new rate to the nearest 0.125%.
- Other ARM types. Interest-only ARMs, six-month adjustments and loans with payment caps behave differently.
- Fees. Points and closing costs can differ between the two offers; compare the APRs on the loan estimates as well.
- Tax, insurance and PMI. They are the same under both options and are left out.