Differences between fixed and adjustable rate loans
With a fixed-rate loan, your monthly payment never changes for the entire duration of the loan. The amount that goes to your principal (the amount you borrowed) will go up, but the amount you pay in interest will go down accordingly. The property taxes and homeowners insurance which are almost always part of the payment will increase over time, but in general, payment amounts on fixed rate loans change little over the life of the loan.
When you first take out a fixed-rate loan, most of the payment is applied to interest. As you pay , more of your payment goes toward principal.
You 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 low rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can offer greater consistency in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we can help you lock in a fixed-rate at the best rate currently available. Call Power Purchase Mortgage at (877) 226-8191 for details.
There are many different kinds of Adjustable Rate Mortgages. Generally, interest rates on ARMs are determined by a federal index. A few of these are: the 6-month Certificate of Deposit (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 ARMs are capped, which means they won't increase over a specified amount in a given period. There may be a cap on interest rate variances over the course of a year. For example: no more than two percent per year, even if the index the rate is based on increases by more than two percent. Sometimes an ARM has a "payment cap" that ensures that your payment can't increase beyond a fixed amount over the course of a given year. The majority of ARMs also cap your rate over the duration of the loan.
ARMs usually start out at a very low rate that may increase over time. You've likely heard of 5/1 or 3/1 ARMs. In these loans, the introductory rate is fixed for three or five years. After this period it adjusts every year. These loans are fixed for 3 or 5 years, then adjust. Loans like this are often best for borrowers who expect to move within three or five years. These types of adjustable rate loans benefit people who plan to move before the initial lock expires.
You might choose an ARM to get a very low initial interest rate and plan on moving, refinancing or simply absorbing the higher rate after the initial rate goes up. ARMs are risky if property values decrease and borrowers are unable to sell or refinance.
Have questions about mortgage loans? Call us at (877) 226-8191. It's our job to answer these questions and many others, so we're happy to help!