Differences between adjustable and fixed rate loans
With a fixed-rate loan, your payment never changes for the entire duration of the loan. The portion of the payment that goes to your principal (the amount you borrowed) will increase, however, your interest payment will go down in the same amount. Your property taxes may go up (or rarely, down), and your insurance rates might vary as well. But generally payment amounts on your fixed-rate loan will be very stable.
During the early amortization period of a fixed-rate loan, most of your payment pays interest, and a much smaller percentage goes to principal. As you pay , more of your payment is applied to principal.
You can 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 wish to lock in at the lower rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can provide more consistency in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we can assist you in locking a fixed-rate at a good rate. Call Real Property Finance at 310-379-5997 to learn more.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, the interest on ARMs are based on an outside 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 programs have a cap that protects you from sudden monthly payment increases. Some ARMs won't adjust 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 directly, caps the amount that the payment can increase in a given period. Almost all ARMs also cap your rate over the duration of the loan.
ARMs usually start at a very low rate that usually increases over time. You've probably read about 5/1 or 3/1 ARMs. In these loans, the initial rate is fixed for three or five years. After this period it adjusts every year. These types of loans are fixed for 3 or 5 years, then adjust after the initial period. Loans like this are often best for people who expect to move within three or five years. These types of adjustable rate loans most benefit people who will move before the loan adjusts.
Most borrowers who choose ARMs do so when they want to take advantage of lower introductory rates and don't plan on remaining in the house longer than the introductory low-rate period. ARMs can be risky when housing prices go down because homeowners can get stuck with increasing rates when they cannot sell their home or refinance with a lower property value.
Have questions about mortgage loans? Call us at 310-379-5997. We answer questions about different types of loans every day.