Differences between adjustable and fixed loans
With a fixed-rate loan, your payment doesn't change for the life of your loan. The amount allocated to your principal (the loan amount) goes up, but the amount you pay in interest 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. For the most part payments for a fixed-rate mortgage will increase very little.
When you first take out a fixed-rate mortgage loan, the majority the payment is applied to interest. As you pay , more of your payment is applied to principal.
Borrowers might choose a fixed-rate loan to lock in a low interest rate. Borrowers select these types of loans because interest rates are low and they wish to lock in the lower 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'll be glad to assist you in locking a fixed-rate at a favorable rate. Call Power Purchase Mortgage at (800)593-0143 to learn more.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, interest rates on ARMs are determined by an outside index. Some examples of outside indexes are: the 6-month CD rate, the 1 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 can't go up over a specific amount in a given period. Your ARM may feature a cap on interest rate variances over the course of a year. For example: no more than a couple percent a year, even though the index the rate is based on increases by more than two percent. Your loan may have a "payment cap" that instead of capping the interest directly, caps the amount the monthly payment can increase in one period. Additionally, the great majority of adjustable programs feature a "lifetime cap" — this means that the interest rate can't go over the cap amount.
ARMs most often have their lowest rates toward the start of the loan. They usually guarantee the lower interest rate for an initial period that varies greatly. You may have heard about "3/1 ARMs" or "5/1 ARMs". In these loans, the introductory 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 after the initial period. These loans are often best for people who anticipate moving within three or five years. These types of ARMs benefit people who plan to sell their house or refinance before the initial lock expires.
Most people who choose ARMs choose them when they want to get lower introductory rates and don't plan on staying in the house for any longer than this introductory low-rate period. ARMs can be risky in a down market because homeowners can get stuck with increasing rates when they can't sell or refinance at the lower property value.
Have questions about mortgage loans? Call us at (800)593-0143. We answer questions about different types of loans every day.