Differences between adjustable and fixed rate loans
With a fixed-rate loan, your payment stays the same for the entire duration of your mortgage. The portion of the payment that goes for principal (the actual loan amount) will go up, but your interest payment will go down in the same amount. The property taxes and homeowners insurance will increase over time, but generally, payment amounts on fixed rate loans change little over the life of the loan.
During the early amortization period of a fixed-rate loan, most of your payment pays interest, and a significantly smaller part goes to principal. The amount applied to principal increases up slowly each month.
Borrowers might choose a fixed-rate loan to lock in a low rate. Borrowers select fixed-rate loans when interest rates are low and they want to lock in at this low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can provide more 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 Statewide Funding at (415) 456-7802 to learn more.
There are many different types of Adjustable Rate Mortgages. Generally, the interest rates on ARMs are based on an outside 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.
Most programs feature a cap that protects you from sudden increases in monthly payments. There may be a cap on how much your interest rate can go up in one period. For example: no more than two percent a year, even if the index the rate is based on goes up by more than two percent. Sometimes an ARM has a "payment cap" which ensures your payment will not go above a fixed amount over the course of a given year. In addition, almost all ARM programs have a "lifetime cap" — this means that your rate will never go over the capped amount.
ARMs most often have their lowest rates at the start of the loan. They provide that rate for an initial period that varies greatly. You may hear people talking about "3/1 ARMs" or "5/1 ARMs". In these loans, the introductory rate is set for three or five years. After this period it adjusts every year. These types of loans are fixed for 3 or 5 years, then they adjust. Loans like this are often best for people who expect to move in three or five years. These types of adjustable rate programs benefit borrowers who plan to sell their house or refinance before the initial lock expires.
Most borrowers who choose ARMs do so because they want to take advantage of 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 rates that go up if they cannot sell their home or refinance at the lower property value.
Have questions about mortgage loans? Call us at (415) 456-7802. It's our job to answer these questions and many others, so we're happy to help!