Adjustable versus fixed rate loans
With a fixed-rate loan, your payment remains the same for the entire duration of your loan. The portion allocated for principal (the actual loan amount) goes up, however, 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. But generally monthly payments for a fixed-rate loan will increase very little.
During the early amortization period of a fixed-rate loan, a large percentage of your payment goes toward interest, and a much smaller percentage toward principal. That gradually reverses as the loan ages.
You might choose a fixed-rate loan in order to lock in a low rate. People choose fixed-rate loans when interest rates are low and they want to lock in at the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can offer more monthly payment stability. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to assist you in locking a fixed-rate at the best rate currently available. Call Avalon Mortgage Services, Inc. at (708) 403-5181 to discuss your situation with one of our professionals.
Adjustable Rate Mortgages — ARMs, as we called them above — come in a great number of varieties. Generally, interest on ARMs are determined by a federal index. Some examples of outside indexes are: the 6-month CD rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most ARM programs have a cap that protects you from sudden monthly payment increases. Some ARMs won't adjust more than 2% per year, regardless of the underlying interest rate. Sometimes an ARM has a "payment cap" which ensures that your payment will not increase beyond a certain amount over the course of a given year. The majority of ARMs also cap your interest rate over the duration of the loan.
ARMs usually start out at a very low rate that usually increases over time. You may have heard about "3/1 ARMs" or "5/1 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 they adjust. These loans are best for people who expect to move within three or five years. These types of adjustable rate programs benefit people who will move before the initial lock expires.
Most borrowers who choose ARMs choose them because they want to get lower introductory rates and don't plan to stay in the house longer than the introductory low-rate period. ARMs can be risky when housing prices go down because homeowners could be stuck with rates that go up when they cannot sell or refinance at the lower property value.
Have questions about mortgage loans? Call us at (708) 403-5181. It's our job to answer these questions and many others, so we're happy to help!