Fixed versus adjustable rate loans
With a fixed-rate loan, your payment never changes for the entire duration of your mortgage. The portion of the payment that goes to principal (the actual loan amount) will increase, but the amount you pay in interest will go down accordingly. The property tax and homeowners insurance which are almost always part of the payment will increase over time, but for the most part, payment amounts on these types of loans change little over the life of the loan.
Early in a fixed-rate loan, a large percentage of your monthly payment goes toward interest, and a significantly smaller part goes to principal. That gradually reverses itself as the loan ages.
Borrowers might choose a fixed-rate loan in order to lock in a low interest rate. People select fixed-rate loans because interest rates are low and they want to lock in this lower rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can offer greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we'd love to help you lock in a fixed-rate at a good rate. Call Avalon Mortgage Services, Inc. at (708) 403-5181 to learn more.
There are many different kinds of Adjustable Rate Mortgages. Generally, the interest rates on ARMs are based on an outside index. Some examples of outside indexes are: the 6-month Certificate of Deposit (CD) rate, the one-year rate on Treasure Securities, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most ARMs feature this cap, so they can't increase above a specific amount in a given period of time. Some ARMs can't increase more than two percent per year, regardless of the underlying interest rate. Your loan may have a "payment cap" that instead of capping the interest rate directly, caps the amount the monthly payment can go up in one period. Almost all ARMs also cap your interest rate over the life of the loan period.
ARMs usually start out at a very low rate that may increase over time. You may hear people talking 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 types of loans are fixed for a certain number of years (3 or 5), then adjust. These loans are best for borrowers who anticipate moving within three or five years. These types of adjustable rate programs are best for borrowers who will sell their house or refinance before the initial lock expires.
Most borrowers who choose ARMs do so because they want to get lower introductory rates and don't plan to remain in the home longer than the initial low-rate period. 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 (708) 403-5181. It's our job to answer these questions and many others, so we're happy to help!