Differences between adjustable and fixed rate loans

With a fixed-rate loan, your monthly payment doesn't change for the life of your mortgage. The longer you pay, the more of your payment goes toward principal. The property tax and homeowners insurance will go up over time, but in general, payments on these types of loans vary little.

At the beginning of a a fixed-rate mortgage loan, most of the payment is applied to interest. That reverses as the loan ages.

You can choose a fixed-rate loan to lock in a low interest rate. Borrowers select fixed-rate loans because interest rates are low and they want to lock in this low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can offer more consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we can help you lock in a fixed-rate at a good rate. Call Dick Lepre at (415) 244-9383 to learn more.

Adjustable Rate Mortgages — ARMs, as we called them above — come in many varieties. Generally, the interest on ARMs are determined by a federal index. A few of these are: the 6-month CD rate, the 1 year rate on Treasure Securities, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.

The majority of ARMs feature this cap, which means they won't increase above a specified amount in a given period of time. Some ARMs won't adjust more than two percent per year, regardless of the underlying interest rate. Sometimes an ARM features a "payment cap" that guarantees your payment can't go above a certain amount in a given year. Plus, the great majority of ARM programs have a "lifetime cap" — this cap means that your interest rate can't go over the capped percentage.

ARMs usually start at a very low rate that may increase over time. You've probably heard of 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 loans are fixed for 3 or 5 years, then adjust after the initial period. These loans are often best for borrowers who expect to move within three or five years. These types of adjustable rate programs are best for people who will move before the initial lock expires.

You might choose an ARM to get a lower introductory rate and plan on moving, refinancing or simply absorbing the higher rate after the initial rate expires. 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. We answer questions about different types of loans every day.

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