Differences between adjustable and fixed loans
With a fixed-rate loan, your payment remains the same for the entire duration of your loan. The portion of the payment allocated for your principal (the amount you borrowed) increases, but the amount you pay in interest will go down in the same amount. The property taxes 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.
Your first few years of payments on a fixed-rate loan are applied primarily toward interest. As you pay , more of your payment goes toward principal.
You can choose a fixed-rate loan in order to lock in a low rate. Borrowers choose these types of loans because interest rates are low and they wish to lock in this lower rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can provide more 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 a favorable rate. Call American Mortgage Advisers, Inc at 214-865-7442 to learn more.
Adjustable Rate Mortgages — ARMs, as we called them above — come in a great number of varieties. Generally, interest rates on ARMs are determined by a federal index. Some examples of outside indexes are: the 6-month Certificate of Deposit (CD) rate, the 1 year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most Adjustable Rate Mortgages are capped, which means they can't go up above a specified amount in a given period of time. 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 underlying index increases by more than two percent. Your loan may have a "payment cap" that instead of capping the interest rate directly, caps the amount that your payment can go up in one period. In addition, the great majority of adjustable programs feature a "lifetime cap" — your rate can't ever exceed the capped percentage.
ARMs usually start at a very low rate that usually increases as the loan ages. You may hear people talking about "3/1 ARMs" or "5/1 ARMs". In these loans, the introductory 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 adjust after the initial period. Loans like this are best for borrowers who anticipate moving within three or five years. These types of ARMs are best for borrowers who will sell their house or refinance before the initial lock expires.
Most people who choose ARMs do so because they want to get lower introductory rates and don't plan on staying in the home longer than the initial low-rate period. ARMs can be risky if property values go down and borrowers are unable to sell or refinance.
Have questions about mortgage loans? Call us at 214-865-7442. We answer questions about different types of loans every day.