Differences between adjustable and fixed rate loans
A fixed-rate loan features a fixed payment amount for the entire duration of the mortgage. The property tax and homeowners insurance will increase over time, but in general, payment amounts on these types of loans change little over the life of the loan.
During the early amortization period of a fixed-rate loan, a large percentage of your payment pays interest, and a much smaller part toward principal. The amount applied to your principal amount increases up slowly each month.
Borrowers can choose a fixed-rate loan to lock in a low rate. Borrowers select fixed-rate loans because interest rates are low and they want to lock in the lower rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can offer more 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 for details.
There are many types of Adjustable Rate Mortgages. Generally, the interest rates on ARMs are based on a federal index. Some examples of outside indexes are: the 6-month CD rate, the one-year rate on Treasure Securities, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most ARMs are capped, which means they can't increase above a specific amount in a given period. There may be a cap on interest rate variances over the course of a year. For example: no more than a couple percent a year, even if the index the rate is based on increases by more than two percent. Sometimes an ARM has a "payment cap" which guarantees that your payment will not go above a fixed amount in a given year. Additionally, the great majority of adjustable programs have a "lifetime cap" — the rate won't exceed the cap percentage.
ARMs most often feature the lowest, most attractive rates at the beginning of the loan. They usually provide that interest rate for an initial period that varies greatly. You may have heard about "3/1 ARMs" or "5/1 ARMs". For these loans, the introductory rate is fixed for three or five years. It then adjusts every year. These kinds of loans are fixed for a number of years (3 or 5), then they adjust. Loans like this are usually best for people who expect to move in three or five years. These types of adjustable rate loans benefit borrowers who will move before the initial lock expires.
You might choose an ARM to get a very low introductory interest rate and plan on moving, refinancing or simply absorbing the higher rate after the initial rate goes up. ARMs are risky if property values go down and borrowers can't sell or refinance.
Have questions about mortgage loans? Call us at (415) 244-9383. It's our job to answer these questions and many others, so we're happy to help!