Adjustable versus fixed rate loans
With a fixed-rate loan, your payment doesn't change for the entire duration of the mortgage. The portion that goes to principal (the loan amount) goes up, but the amount you pay in interest will decrease accordingly. The property tax and homeowners insurance will increase over time, but for the most part, payment amounts on fixed rate loans vary little.
During the early amortization period of a fixed-rate loan, most of your payment goes toward interest, and a significantly smaller part toward principal. The amount applied to principal increases up gradually every month.
You might choose a fixed-rate loan to lock in a low rate. People select fixed-rate loans when interest rates are low and they wish to lock in this lower rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can offer greater monthly payment stability. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to assist you in locking a fixed-rate at a good rate. Call Budica Financial Corporation at (951)840-4188 to discuss your situation with one of our professionals.
There are many kinds of Adjustable Rate Mortgages. Generally, the interest rates on ARMs are based on an outside index. A few of these are: the 6-month CD rate, the 1 year rate on Treasure Securities, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most programs feature a cap that protects you from sudden monthly payment increases. There may be a cap on interest rate increases over the course of a year. For example: no more than two percent a year, even if the underlying index increases by more than two percent. Your loan may have a "payment cap" that instead of capping the interest rate directly, caps the amount that your monthly payment can go up in one period. The majority of ARMs also cap your interest rate over the life of the loan.
ARMs usually start out at a very low rate that may increase over time. You've probably heard of 5/1 or 3/1 ARMs. In these loans, the introductory rate is fixed for three or five years. After this period it adjusts every year. These loans are fixed for 3 or 5 years, then adjust after the initial period. Loans like this are usually best for borrowers who anticipate moving within three or five years. These types of ARMs are best for people who plan to move before the loan adjusts.
Most borrowers who choose ARMs choose them when they want to take advantage of lower introductory rates and don't plan to remain in the house longer than the introductory low-rate period. ARMs can be risky in a down market because homeowners could be stuck with increasing rates when they can't sell or refinance with a lower property value.