Differences between fixed and adjustable rate loans
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With a fixed-rate loan, your monthly payment never changes for the life of your loan. The longer you pay, the more of your payment goes toward principal. The property tax and homeowners insurance which are almost always part of the payment will go up over time, but for the most part, payment amounts on these types of loans change little over the life of the loan.
At the beginning of a a fixed-rate loan, most of your payment is applied to interest. 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 interest rate. Borrowers select these types of loans because interest rates are low and they wish to lock in at the lower rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can provide greater monthly payment stability. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to help you lock in a fixed-rate at a good rate. Call Dick Lepre at (415) 244-9383 to discuss your situation with one of our professionals.
There are many kinds of Adjustable Rate Mortgages. Generally, interest for ARMs are determined by an outside index. A few of these 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 ARM programs feature a cap that protects you 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 underlying index increases by more than two percent. Your loan may feature a "payment cap" that instead of capping the interest rate directly, caps the amount that the monthly payment can increase in one period. Additionally, the great majority of ARMs have a "lifetime cap" — this cap means that the interest rate can't exceed the capped amount.
ARMs usually start out 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. After this period it adjusts every year. These loans are fixed for a number of years (3 or 5), then they adjust. Loans like this are often best for people who anticipate moving in three or five years. These types of adjustable rate loans most benefit people who plan to move before the loan adjusts.
You might choose an Adjustable Rate Mortgage to take advantage of a very low introductory rate and count 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 are unable to sell their home or refinance their loan.
Have questions about mortgage loans? Call us at (415) 244-9383. We answer questions about different types of loans every day.