Fixed versus adjustable rate loans
With a fixed-rate loan, your payment never changes for the life of the loan. The portion that goes for 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 in general, payments on these types of loans vary little.
When you first take out a fixed-rate mortgage loan, the majority your payment is applied to interest. The amount paid toward your principal amount increases up slowly every month.
Borrowers might choose a fixed-rate loan to lock in a low rate. People select these types of loans because interest rates are low and they want to lock in at this low rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can provide greater consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to assist you in locking 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 even more varieties. ARMs are generally adjusted twice a year, based on various indexes.
Most ARM programs feature a cap that protects borrowers from sudden increases in monthly payments. There may be a cap on how much your interest rate can go up in one period. For example: no more than two 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 guarantees that your payment will not go above a fixed amount over the course of a given year. The majority of ARMs also cap your rate over the duration of the loan period.
ARMs usually start at a very low rate that may increase as the loan ages. You may have heard about "3/1 ARMs" or "5/1 ARMs". For these loans, the introductory rate is set for three or five years. It then adjusts every year. These loans are fixed for a number of years (3 or 5), then adjust. Loans like this are often best for borrowers who expect to move in three or five years. These types of adjustable rate programs most benefit people who will sell their house or refinance before the loan adjusts.
You might choose an Adjustable Rate Mortgage to take advantage of a lower initial interest rate and count on moving, refinancing or simply absorbing the higher rate after the introductory rate goes up. ARMs can be risky when housing prices go down because homeowners could be stuck with increasing rates if they can't sell or refinance with a lower property value.
Have questions about mortgage loans? Call us at (415) 244-9383. We answer questions about different types of loans every day.