Differences between fixed and adjustable rate loans
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With a fixed-rate loan, your payment remains the same for the entire duration of your mortgage. The longer you pay, the more of your payment goes toward principal. Your property taxes may go up (or rarely, down), and your insurance rates might vary as well. But generally monthly payments for your fixed-rate mortgage will increase very little.
Early in a fixed-rate loan, most of your payment goes toward interest, and a significantly smaller percentage goes to principal. The amount paid toward your principal amount goes up gradually each month.
Borrowers can choose a fixed-rate loan in order to lock in a low rate. Borrowers choose these types of loans because interest rates are low and they wish to lock in at the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can offer greater monthly payment stability. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to assist you in locking a fixed-rate at a good rate. Call Dick Lepre at (415) 244-9383 for details.
There are many different types of Adjustable Rate Mortgages. Generally, interest rates on ARMs are determined by a federal 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.
The majority of Adjustable Rate Mortgages feature this cap, so they can't increase over a certain amount in a given period of time. Some ARMs won't adjust 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 directly, caps the amount your monthly payment can increase in a given period. Additionally, almost all ARM programs have a "lifetime cap" — your rate can't ever exceed the capped percentage.
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". In these loans, the initial rate is fixed for three or five years. It then adjusts every year. These kinds of loans are fixed for a certain number of years (3 or 5), then they adjust. These loans are usually best for borrowers who expect to move within three or five years. These types of adjustable rate programs most benefit people who will sell their house or refinance before the initial lock expires.
You might choose an Adjustable Rate Mortgage to get a lower initial rate and count on moving, refinancing or absorbing the higher rate after the initial rate expires. ARMs can be risky in a down market because homeowners can get stuck with increasing rates if they cannot sell their home or refinance at the lower property value.
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