Differences between fixed and adjustable loans
With a fixed-rate loan, your monthly payment never changes for the life of the loan. The amount of the payment allocated for principal (the actual loan amount) will go up, however, your interest payment will go down in the same amount. Your property taxes may go up (or rarely, down), and so might the homeowner's insurance in your monthly payment. But generally payments on a fixed-rate loan will be very stable.
At the beginning of a a fixed-rate loan, most of your payment is applied to interest. That reverses as the loan ages.
Borrowers might choose a fixed-rate loan in order to lock in a low rate. People select these types of loans when interest rates are low and they want to lock in the lower rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can offer more stability 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 good rate. Call Strategic Home Loans, Inc. at (805) 496-7500 for details.
Adjustable Rate Mortgages — ARMs, come in many varieties. Generally, interest on ARMs are based on 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 Adjustable Rate Mortgages are capped, so they won't increase above a certain amount in a given period of time. Your ARM may feature a cap on interest rate increases over the course of a year. For example: no more than two percent per year, even if the underlying index increases by more than two percent. Sometimes an ARM has a "payment cap" which ensures that your payment won't increase beyond a certain amount in a given year. The majority of ARMs also cap your rate over the duration of the loan period.
ARMs most often feature their lowest rates toward the beginning. They usually guarantee that rate for an initial period that varies greatly. You've probably 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 types of loans are fixed for 3 or 5 years, then they adjust. These loans are usually best for borrowers who expect to move in three or five years. These types of adjustable rate programs most benefit borrowers who plan to move before the loan adjusts.
You might choose an Adjustable Rate Mortgage to get a lower introductory interest rate and count on moving, refinancing or simply absorbing the higher rate after the introductory rate expires. ARMs can be risky when housing prices go down because homeowners could be stuck with increasing rates when they cannot sell their home or refinance at the lower property value.
Have questions about mortgage loans? Call us at (805) 496-7500. We answer questions about different types of loans every day.