Differences between fixed and adjustable loans
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With a fixed-rate loan, your monthly payment doesn't change for the life of the loan. The amount of the payment that goes for your principal (the actual loan amount) goes up, but your interest payment will decrease accordingly. 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 fixed rate loans don't increase much.
During the early amortization period of a fixed-rate loan, most of your monthly payment goes toward interest, and a much smaller part toward principal. As you pay on the loan, more of your payment is applied to principal.
Borrowers can choose a fixed-rate loan to lock in a low rate. People choose fixed-rate loans because interest rates are low and they want to lock in at the low rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can provide greater consistency in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we can help you lock in a fixed-rate at the best rate currently available. Call Dick Lepre at (415) 244-9383 to discuss how we can help.
Adjustable Rate Mortgages — ARMs, come in a great number of varieties. Generally, interest rates on ARMs are based on an outside index. A few of these are: the 6-month CD rate, the 1 year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most programs have a cap that protects borrowers from sudden increases in monthly payments. Some ARMs won't adjust more than 2% per year, regardless of the underlying interest rate. Sometimes an ARM has a "payment cap" which guarantees your payment will not go above a fixed amount over the course of a given year. Additionally, the great majority of ARMs feature a "lifetime cap" — the rate won't exceed the capped percentage.
ARMs most often have their lowest, most attractive rates at the beginning. They usually provide the lower interest rate from a month to ten years. You've probably read about 5/1 or 3/1 ARMs. For these loans, the introductory rate is set for three or five years. It then adjusts every year. These kinds of loans are fixed for 3 or 5 years, then adjust. These loans are best for people who expect to move in three or five years. These types of adjustable rate programs benefit borrowers who will sell their house or refinance before the loan adjusts.
Most people who choose ARMs choose them because they want to take advantage of lower introductory rates and do not plan to stay in the house longer than the introductory low-rate period. ARMs can be risky when housing prices go down because homeowners can get stuck with rates that go up if they cannot sell their home or refinance at the lower property value.
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