Differences between adjustable and fixed rate loans
With a fixed-rate loan, your monthly payment remains the same for the life of the loan. The amount of the payment that goes for your principal (the actual loan amount) will increase, but the amount you pay in interest will decrease accordingly. The property taxes and homeowners insurance will increase over time, but generally, payment amounts on these types of loans change little over the life of the loan.
Early in a fixed-rate loan, most of your monthly payment pays interest, and a significantly smaller percentage goes to principal. This proportion gradually reverses as the loan ages.
You might choose a fixed-rate loan to lock in a low rate. People select fixed-rate loans when interest rates are low and they want to lock in at the low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can provide more monthly payment stability. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to help you lock in a fixed-rate at the best rate currently available. Call Capacity Lending, LLC at 469-640-0400 to learn more.
Adjustable Rate Mortgages — ARMs, come in many varieties. Generally, the interest for ARMs are based on a federal index. Some examples of outside indexes 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 borrowers from sudden increases in monthly payments. Some ARMs won't increase more than 2% per year, regardless of the underlying interest rate. Your loan may feature a "payment cap" that instead of capping the interest directly, caps the amount the monthly payment can increase in one period. Plus, almost all ARM programs feature a "lifetime cap" — this cap means that your rate can't ever exceed the cap percentage.
ARMs usually start out at a very low rate that may increase as the loan ages. You've probably heard of 5/1 or 3/1 ARMs. For 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 people who expect to move within 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.
You might choose an ARM to get a lower introductory interest rate and count on moving, refinancing or simply absorbing the higher rate after the introductory rate expires. ARMs are risky if property values decrease and borrowers can't sell their home or refinance their loan.
Have questions about mortgage loans? Call us at 469-640-0400. We answer questions about different types of loans every day.