Adjustable versus fixed rate loans
With a fixed-rate loan, your payment never changes for the entire duration of your loan. The amount of the payment that goes to principal (the loan amount) increases, however, the amount you pay in interest will go down in the same amount. Your property taxes increase, or rarely, decrease, and so might the homeowner's insurance in your monthly payment. But generally payment amounts for your fixed-rate loan will be very stable.
During the early amortization period of a fixed-rate loan, most of your payment goes toward interest, and a significantly smaller percentage goes to principal. The amount paid toward your principal amount goes up gradually every month.
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 want to lock in at the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can offer greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), 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, as we called them above — come in a great number of varieties. Generally, interest rates for ARMs are determined by a federal index. Some examples of outside indexes 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 ARM programs feature a cap that protects borrowers from sudden increases in monthly payments. Some ARMs won't increase more than two percent per year, regardless of the underlying interest rate. Sometimes an ARM features a "payment cap" which guarantees your payment will not go above a fixed amount in a given year. In addition, almost all ARMs have a "lifetime cap" — this means that your interest rate won't go over the cap amount.
ARMs usually start out at a very low rate that may increase over time. You may hear people talking about "3/1 ARMs" or "5/1 ARMs". For 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. These loans are often best for people who expect to move in three or five years. These types of ARMs are best for borrowers who will move before the loan adjusts.
You might choose an Adjustable Rate Mortgage to get a very low introductory interest rate and plan on moving, refinancing or simply absorbing the higher rate after the initial rate expires. ARMs can be risky when housing prices go down because homeowners can get stuck with rates that go up when they cannot sell their home or refinance with a lower property value.