Differences between adjustable and fixed loans
With a fixed-rate loan, your monthly payment doesn't change for the entire duration of the mortgage. The portion of the payment that goes for principal (the loan amount) goes up, but the amount you pay in interest will decrease in the same amount. Your property taxes may go up (or rarely, down), and your insurance rates might vary as well. But generally monthly payments on a fixed-rate mortgage will be very stable.
Your first few years of payments on a fixed-rate loan go primarily toward interest. This proportion reverses as the loan ages.
You might choose a fixed-rate loan to lock in a low rate. People choose these types of loans because interest rates are low and they want to lock in at the lower rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can offer greater stability in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'll be glad to assist you in locking a fixed-rate at a good rate. Call Metro Mortgage at 866-300-1550 to learn more.
Adjustable Rate Mortgages — ARMs, as we called them above — come in a great number of varieties. Generally, interest rates for ARMs are determined by an outside index. Some examples of outside indexes 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, which means they won't go up over a specific amount in a given period. Some ARMs won't adjust more than 2% per year, regardless of the underlying interest rate. Sometimes an ARM has a "payment cap" which ensures your payment won't increase beyond a fixed amount over the course of a given year. Additionally, the great majority of ARM programs feature a "lifetime cap" — this cap means that your rate can never go over the cap percentage.
ARMs most often feature the lowest rates toward the beginning of the loan. They provide that rate from a month to ten years. You may have heard about "3/1 ARMs" or "5/1 ARMs". For these loans, the initial rate is fixed for three or five years. After this period it adjusts every year. These kinds of loans are fixed for 3 or 5 years, then adjust after the initial period. These loans are usually best for borrowers who anticipate moving in three or five years. These types of ARMs most benefit borrowers who plan to sell their house or refinance before the loan adjusts.
Most people who choose ARMs choose them when they want to get lower introductory rates and do not plan to stay in the house longer than the initial low-rate period. ARMs can be risky if property values decrease and borrowers are unable to sell or refinance their loan.
Have questions about mortgage loans? Call us at 866-300-1550. We answer questions about different types of loans every day.