Fixed versus adjustable loans
With a fixed-rate loan, your payment doesn't change for the entire duration of the mortgage. The portion of the payment allocated for your principal (the loan amount) increases, but the amount you pay in interest will go down in the same amount. Your property taxes may go up (or rarely, down), and your insurance rates might vary as well. For the most part monthly payments for your fixed-rate loan will increase very little.
At the beginning of a a fixed-rate mortgage loan, most of your payment goes toward interest. That gradually reverses as the loan ages.
Borrowers can choose a fixed-rate loan to lock in a low rate. People choose fixed-rate loans when interest rates are low and they wish to lock in the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can provide greater consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'll be glad to assist you in locking a fixed-rate at a good rate. Call Real Property Finance at 310-379-5997 for details.
Adjustable Rate Mortgages — ARMs, come in many varieties. Generally, interest rates for ARMs are based on an outside index. Some examples of outside indexes are: the 6-month Certificate of Deposit (CD) rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most Adjustable Rate Mortgages are capped, which means they can't increase over a specified amount in a given period of time. There may be a cap on interest rate increases over the course of a year. For example: no more than two percent per year, even if the index the rate is based on increases by more than two percent. Sometimes an ARM features a "payment cap" which ensures that your payment can't go above a fixed amount over the course of a given year. In addition, the great majority of ARM programs have a "lifetime cap" — your interest rate won't exceed the capped percentage.
ARMs most often have their lowest rates toward the start of the loan. They usually provide that interest rate from a month to ten years. You've likely heard of 5/1 or 3/1 ARMs. In these loans, the introductory rate is set for three or five years. After this period it adjusts every year. These loans are fixed for 3 or 5 years, then adjust. These loans are best for borrowers who anticipate moving within three or five years. These types of adjustable rate programs benefit borrowers who will move before the loan adjusts.
You might choose an Adjustable Rate Mortgage to get a lower introductory rate and plan on moving, refinancing or simply absorbing the higher rate after the initial rate goes up. ARMs can be risky in a down market because homeowners can get stuck with increasing rates if they can't 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.