Adjustable versus fixed rate loans
With a fixed-rate loan, your monthly payment remains the same for the entire duration of your loan. The longer you pay, the more of your payment goes toward principal. The property tax and homeowners insurance which are almost always part of the payment will increase over time, but for the most part, payments on these types of loans don't increase much.
Your first few years of payments on a fixed-rate loan are applied primarily toward interest. As you pay , more of your payment is applied to principal.
You can choose a fixed-rate loan in order to lock in a low interest rate. People select these types of loans because interest rates are low and they want to lock in this lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can provide more stability in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we can help you lock in a fixed-rate at the best rate currently available. Call Budica Financial Corporation at (951)840-4188 to discuss your situation with one of our professionals.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, the interest on ARMs are determined by a federal index. Some examples of outside indexes are: the 6-month Certificate of Deposit (CD) rate, the 1 year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most programs have a cap that protects you from sudden monthly payment increases. Your ARM may feature a cap on interest rate variances over the course of a year. For example: no more than a couple percent a year, even though the underlying index increases by more than two percent. Sometimes an ARM has a "payment cap" which guarantees that your payment will not increase beyond a fixed amount in a given year. Almost all ARMs also cap your interest rate over the life of the loan.
ARMs most often feature their lowest, most attractive rates at the start. They usually provide the lower interest rate from a month to ten years. You've probably read about 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 adjust. These loans are usually best for borrowers who expect to move 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.
Most people who choose ARMs choose them when they want to get lower introductory rates and don't plan on staying in the house for any longer than this initial low-rate period. ARMs are risky when property values go down and borrowers can't sell their home or refinance their loan.