Differences between fixed and adjustable loans

With a fixed-rate loan, your payment remains the same for the life of your loan. The longer you pay, the more of your payment goes toward principal. The property tax and homeowners insurance will increase over time, but for the most part, payment amounts on these types of loans vary little.

Your first few years of payments on a fixed-rate loan go mostly toward interest. That reverses as the loan ages.

Borrowers might choose a fixed-rate loan to lock in a low rate. People choose these types of loans when interest rates are low and they wish to lock in at this lower rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can offer greater consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we can assist you in locking a fixed-rate at a good rate. Call Dick Lepre at (415) 244-9383 for details.

Adjustable Rate Mortgages — ARMs, as we called them above — come in many varieties. Generally, the interest for ARMs are based on an outside index. Some examples of outside indexes are: the 6-month Certificate of Deposit (CD) rate, the one-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 feature this cap, which means they won't go up above a specific amount in a given period. Your ARM may feature a cap on interest rate increases over the course of a year. For example: no more than two percent a year, even though the underlying index increases by more than two percent. Sometimes an ARM has a "payment cap" that guarantees your payment won't increase beyond a certain amount in a given year. Most ARMs also cap your rate over the duration of the loan.

ARMs usually start at a very low rate that usually increases as the loan ages. You've probably heard of 5/1 or 3/1 ARMs. In these loans, the initial rate is set for three or five years. After this period it adjusts every year. These types of loans are fixed for 3 or 5 years, then adjust. These loans are best for people who expect to move within three or five years. These types of adjustable rate programs are best for people who plan to sell their house or refinance before the loan adjusts.

Most borrowers who choose ARMs do so when they want to take advantage of lower introductory rates and do not plan on remaining in the house for any longer than the introductory low-rate period. ARMs can be risky when housing prices go down because homeowners can get stuck with increasing rates when they cannot 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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