Differences between adjustable and fixed rate loans

A fixed-rate loan features the same payment over the life of the loan. The property tax and homeowners insurance which are almost always part of the payment will go up over time, but in general, payment amounts on fixed rate loans don't increase much.

Your first few years of payments on a fixed-rate loan are applied mostly to pay interest. The amount applied to principal increases up slowly every month.

You might choose a fixed-rate loan in order to lock in a low interest rate. Borrowers choose fixed-rate loans because interest rates are low and they want to lock in at this low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can provide more stability in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to help you lock in a fixed-rate at the best rate currently available. Call Dick Lepre at (415) 244-9383 to learn more.

Adjustable Rate Mortgages — ARMs, as we called them above — 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 Certificate of Deposit (CD) rate, the 1 year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.

Most ARM programs feature a cap that protects borrowers from sudden monthly payment increases. There may be a cap on how much your interest rate can increase in one period. For example: no more than a couple percent per year, even though the index the rate is based on increases by more than two percent. Sometimes an ARM has a "payment cap" that ensures that your payment won't increase beyond a certain amount over the course of a given year. In addition, the great majority of ARMs have a "lifetime cap" — the interest rate can't exceed the capped amount.

ARMs most often feature the lowest rates at the start. They provide that rate from a month to ten years. You've probably heard of 5/1 or 3/1 ARMs. For these loans, the initial rate is set for three or five years. It then adjusts every year. These loans are fixed for a number of years (3 or 5), then they adjust. Loans like this are often best for borrowers who expect to move within three or five years. These types of adjustable rate programs most benefit borrowers who plan to move before the loan adjusts.

Most borrowers who choose ARMs do so when they want to take advantage of lower introductory rates and don't plan to remain in the house for any longer than this introductory low-rate period. ARMs are risky if property values decrease and borrowers can't sell their home or refinance.

Have questions about mortgage loans? Call us at (415) 244-9383. We answer questions about different types of loans every day.

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