Differences between fixed and adjustable rate loans
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With a fixed-rate loan, your payment doesn't change for the life of your mortgage. The amount allocated to your principal (the actual loan amount) goes up, but your interest payment will decrease accordingly. The property taxes and homeowners insurance which are almost always part of the payment will increase over time, but generally, payment amounts on fixed rate loans change little over the life of the loan.
Your first few years of payments on a fixed-rate loan are applied primarily to pay interest. The amount applied to principal goes up slowly every month.
You might choose a fixed-rate loan to lock in a low rate. Borrowers choose these types of loans when interest rates are low and they wish to lock in the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can provide greater stability in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we'd love to help you lock in a fixed-rate at a favorable rate. Call First Residential Mortgage at (831) 459-6073 to learn more.
Adjustable Rate Mortgages — ARMs, come in a great number of varieties. Generally, the interest rates for ARMs are determined by an outside index. A few of these are: the 6-month CD rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most Adjustable Rate Mortgages are capped, which means they can't increase over a specific amount in a given period. Some ARMs won't increase more than two percent per year, regardless of the underlying interest rate. Your loan may have a "payment cap" that instead of capping the interest rate directly, caps the amount your monthly payment can increase in a given period. Additionally, almost all ARM programs have a "lifetime cap" — this cap means that your interest rate can never exceed the cap percentage.
ARMs most often feature the lowest, most attractive rates at the beginning. They usually provide that rate for an initial period that varies greatly. You've likely read about 5/1 or 3/1 ARMs. For these loans, the introductory rate is set for three or five years. It then adjusts every year. These loans are fixed for 3 or 5 years, then they adjust after the initial period. Loans like this are often best for people who anticipate moving in three or five years. These types of ARMs most benefit people who will move before the initial lock expires.
You might choose an Adjustable Rate Mortgage to get a lower introductory interest rate and count on moving, refinancing or absorbing the higher rate after the introductory rate expires. ARMs are risky if property values decrease and borrowers are unable to sell or refinance their loan.
Have questions about mortgage loans? Call us at (831) 459-6073. It's our job to answer these questions and many others, so we're happy to help!