Differences between fixed and adjustable rate loans

A fixed-rate loan features a fixed payment amount for the entire duration of the mortgage. Your property taxes may go up (or rarely, down), and so might the homeowner's insurance in your monthly payment. But generally monthly payments for your fixed-rate mortgage will increase very little.

During the early amortization period of a fixed-rate loan, a large percentage of your monthly payment goes toward interest, and a significantly smaller part toward principal. As you pay on the loan, more of your payment is applied to principal.

Borrowers might choose a fixed-rate loan to lock in a low rate. People choose fixed-rate loans when interest rates are low and they wish to lock in at this lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can provide greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we'll be glad to assist you in locking a fixed-rate at a good rate. Call Dick Lepre at (415) 244-9383 to discuss your situation with one of our professionals.

Adjustable Rate Mortgages — ARMs, as we called them above — come in a great number of varieties. Generally, the interest on ARMs are determined by an outside index. Some examples of outside indexes are: the 6-month CD rate, the 1 year rate on Treasure Securities, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.

The majority of Adjustable Rate Mortgages are capped, so they won't go up over a specific amount in a given period of time. Some ARMs won't adjust more than 2% 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 that your payment can increase in one period. Almost all ARMs also cap your rate over the duration of the loan period.

ARMs most often have the lowest, most attractive rates at the start of the loan. They guarantee that rate from a month to ten years. You may have heard about "3/1 ARMs" or "5/1 ARMs". In these loans, the introductory rate is set for three or five years. After this period it adjusts every year. These loans are fixed for 3 or 5 years, then adjust after the initial period. These loans are best for borrowers who anticipate moving within three or five years. These types of ARMs benefit borrowers who will sell their house or refinance before the loan adjusts.

You might choose an ARM to get a very low introductory interest rate and count on moving, refinancing or simply absorbing the higher rate after the initial rate expires. ARMs can be risky in a down market because homeowners could be stuck with increasing rates if they can't sell or refinance at the lower property value.

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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