Differences between fixed and adjustable loans
A fixed-rate loan features a fixed payment amount for the entire duration of the loan. Your property taxes increase, or rarely, decrease, and so might the homeowner's insurance in your monthly payment. For the most part payments for your fixed-rate mortgage will be very stable.
During the early amortization period of a fixed-rate loan, a large percentage of your payment pays interest, and a much smaller percentage toward principal. The amount applied to principal goes up slowly every month.
Borrowers might choose a fixed-rate loan to lock in a low rate. Borrowers choose fixed-rate loans when interest rates are low and they want to lock in at this low rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can offer more consistency in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we'd love to help you lock in a fixed-rate at a good rate. Call Savers Home Loans at (800) 974-0509 to discuss your situation with one of our professionals.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more 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 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 borrowers from sudden increases in monthly payments. Some ARMs can't adjust more than two percent per year, regardless of the underlying interest rate. Sometimes an ARM features a "payment cap" that ensures that your payment won't go above a certain amount over the course of a given year. In addition, almost all ARMs have a "lifetime cap" — this cap means that the rate will never go over the capped percentage.
ARMs most often feature their lowest rates at the start. They usually guarantee the lower rate for an initial period that varies greatly. You've likely read about 5/1 or 3/1 ARMs. In these loans, the initial rate is fixed for three or five years. It then adjusts every year. These kinds of loans are fixed for 3 or 5 years, then they adjust. These loans are best for borrowers who anticipate moving within three or five years. These types of adjustable rate programs benefit borrowers who plan to move before the loan adjusts.
You might choose an ARM to get a very low initial rate and plan on moving, refinancing or simply absorbing the higher rate after the initial rate goes up. ARMs can be risky in a down market because homeowners could be stuck with rates that go up if they cannot sell or refinance with a lower property value.
Have questions about mortgage loans? Call us at (800) 974-0509. We answer questions about different types of loans every day.