Differences between adjustable and fixed loans
With a fixed-rate loan, your monthly payment remains the same for the entire duration of the mortgage. The portion allocated to principal (the amount you borrowed) increases, however, your interest payment will decrease in the same amount. The property taxes and homeowners insurance will increase over time, but in general, payments on fixed rate loans don't increase much.
Your first few years of payments on a fixed-rate loan go mostly to pay interest. As you pay on the loan, more of your payment goes toward principal.
You might choose a fixed-rate loan in order to lock in a low rate. Borrowers choose these types of loans when interest rates are low and they want to lock in at this lower rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can offer greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we'd love to assist you in locking a fixed-rate at a favorable rate. Call Howard Financial at (610) 889-7467 to discuss how we can help.
Adjustable Rate Mortgages — ARMs, come in many varieties. Generally, interest rates on ARMs are determined by an outside index. Some examples of outside indexes are: the 6-month 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 programs have 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 rate directly, caps the amount your monthly payment can go up in one period. In addition, the great majority of ARM programs have a "lifetime cap" — this means that the interest rate can never go over the cap amount.
ARMs usually start out at a very low rate that usually increases over time. You've probably heard of 5/1 or 3/1 ARMs. For these loans, the initial rate is set for three or five years. After this period it adjusts every year. These kinds of loans are fixed for 3 or 5 years, then they adjust after the initial period. These loans are often best for borrowers who anticipate moving within three or five years. These types of adjustable rate loans are best for borrowers who plan to sell their house or refinance before the initial lock expires.
You might choose an Adjustable Rate Mortgage to take advantage of a very low introductory rate and plan on moving, refinancing or simply absorbing the higher rate after the introductory rate goes up. ARMs are risky if property values decrease and borrowers can't sell or refinance.
Have questions about mortgage loans? Call us at (610) 889-7467. We answer questions about different types of loans every day.