Differences between fixed and adjustable loans
With a fixed-rate loan, your monthly payment never changes for the life of the loan. The portion of the payment allocated for principal (the amount you borrowed) increases, however, your interest payment will decrease accordingly. Your property taxes may go up (or rarely, down), and your insurance rates might vary as well. For the most part monthly payments for a fixed-rate loan will be very stable.
When you first take out a fixed-rate mortgage loan, most of the payment goes toward interest. The amount paid toward principal increases up slowly every month.
You might choose a fixed-rate loan to lock in a low rate. People select these types of loans when interest rates are low and they wish to lock in this low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can offer greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we'd love to help you lock in a fixed-rate at a favorable rate. Call The Reen Team at American Pacific Mortgage at (408) 626-1879 for details.
There are many types of Adjustable Rate Mortgages. Generally, the interest for ARMs are determined by an outside index. A few of these are: the 6-month Certificate of Deposit (CD) rate, the one-year Treasury Security rate, 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 go up over a certain amount in a given period of time. There may be a cap on how much your interest rate can increase in one period. For example: no more than a couple percent per year, even though the index the rate is based on goes up by more than two percent. Sometimes an ARM features a "payment cap" which guarantees that your payment won't go above a certain amount over the course of a given year. Plus, almost all ARMs feature a "lifetime cap" — this means that the interest rate won't exceed the capped percentage.
ARMs usually start at a very low rate that usually increases over time. You've probably read about 5/1 or 3/1 ARMs. In these loans, the introductory rate is set for three or five years. It then adjusts every year. These types of loans are fixed for a number of years (3 or 5), then adjust after the initial period. These loans are usually best for borrowers who anticipate moving within three or five years. These types of ARMs most benefit people who will move before the loan adjusts.
You might choose an Adjustable Rate Mortgage to get a very low initial interest rate and plan on moving, refinancing or absorbing the higher rate after the introductory rate expires. ARMs can be risky when housing prices go down because homeowners can get stuck with increasing rates if they cannot sell their home or refinance at the lower property value.
Have questions about mortgage loans? Call us at (408) 626-1879. It's our job to answer these questions and many others, so we're happy to help!