Adjustable versus fixed rate loans
With a fixed-rate loan, your monthly payment doesn't change for the life of the loan. The amount of the payment that goes for principal (the actual loan amount) will go up, but the amount you pay in interest will decrease in the same amount. The property tax and homeowners insurance which are almost always part of the payment will increase over time, but in general, payments on fixed rate loans vary little.
Your first few years of payments on a fixed-rate loan are applied primarily to pay interest. That gradually reverses as the loan ages.
You can choose a fixed-rate loan in order to lock in a low rate. Borrowers select fixed-rate loans because 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 offer more consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'll be glad to help you lock in a fixed-rate at a good rate. Call Budica Financial Corporation at (951)840-4188 to learn more.
Adjustable Rate Mortgages — ARMs, come in even more varieties. Generally, interest on ARMs are determined by an outside index. Some examples of outside indexes are: the 6-month CD rate, the 1 year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
The majority of Adjustable Rate Mortgages feature this cap, so they can't go up above a specific amount in a given period of time. There may be a cap on how much your interest rate can increase in one period. For example: no more than two percent a year, even if the underlying index goes up by more than two percent. Your loan may feature a "payment cap" that instead of capping the interest directly, caps the amount that the monthly payment can increase in one period. Almost all ARMs also cap your interest rate over the life of the loan period.
ARMs most often feature the lowest rates toward the beginning of the loan. They usually guarantee the lower interest rate for an initial period that varies greatly. You've probably heard of 5/1 or 3/1 ARMs. In these loans, the initial rate is fixed for three or five years. It then adjusts every year. These types of loans are fixed for 3 or 5 years, then they adjust after the initial period. Loans like this are usually best for borrowers who expect to move in three or five years. These types of ARMs benefit borrowers who will sell their house or refinance before the initial lock expires.
You might choose an Adjustable Rate Mortgage to get a very low introductory interest rate and plan on moving, refinancing or absorbing the higher rate after the introductory rate goes up. ARMs can be risky in a down market because homeowners can get stuck with rates that go up if they cannot sell or refinance with a lower property value.