Adjustable versus fixed rate loans

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With a fixed-rate loan, your monthly payment remains the same for the life of your loan. The amount of the payment allocated to principal (the actual loan amount) increases, but your interest payment will decrease accordingly. Your property taxes may go up (or rarely, down), and your insurance rates might vary as well. But generally payment amounts for your fixed-rate loan will increase very little.

During the early amortization period of a fixed-rate loan, most of your monthly payment goes toward interest, and a significantly smaller percentage goes to principal. As you pay on the loan, more of your payment goes toward principal.

Borrowers can choose a fixed-rate loan to lock in a low interest rate. Borrowers choose these types of loans because interest rates are low and they wish to lock in at the low rate. If you have an Adjustable Rate Mortgage (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'd love to assist you in locking a fixed-rate at the best rate currently available. Call Dick Lepre at (415) 244-9383 to discuss your situation with one of our professionals.

Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, the interest for ARMs are based on a federal index. Some examples of outside indexes 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.

Most programs feature a cap that protects you from sudden monthly payment increases. Your ARM may feature a cap on interest rate variances over the course of a year. For example: no more than two percent a year, even if the index the rate is based on goes up by more than two percent. Sometimes an ARM has a "payment cap" which ensures your payment will not increase beyond a certain amount in a given year. Most ARMs also cap your rate over the duration of the loan.

ARMs most often have the lowest, most attractive rates toward the start of the loan. They provide that rate from a month to ten years. You may hear people talking about "3/1 ARMs" or "5/1 ARMs". For these loans, the introductory rate is set 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 adjust after the initial period. Loans like this are usually best for people who expect to move in three or five years. These types of ARMs are best for people who plan to sell their house or refinance before the loan adjusts.

Most borrowers who choose ARMs do so when they want to get lower introductory rates and do not plan on staying in the house longer than the introductory low-rate period. ARMs can be risky when housing prices go down because homeowners could be stuck with rates that go up when they can't sell their home or refinance at the lower property value.

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!

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