Differences between adjustable and fixed loans

A fixed-rate loan features the same payment amount for the entire duration of your mortgage. The property tax and homeowners insurance will go up over time, but in general, payment amounts on these types of loans vary little.

Early in a fixed-rate loan, a large percentage of your monthly payment pays interest, and a much smaller part goes to principal. That reverses as the loan ages.

Borrowers can choose a fixed-rate loan in order to lock in a low interest rate. Borrowers select these types of loans because interest rates are low and they wish to lock in at the lower rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can offer more monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we'll be glad to assist you in locking a fixed-rate at the best rate currently available. Call Southwest Funding #841 at (512) 291-6100 for details.

Adjustable Rate Mortgages — ARMs, as we called them above — come in many varieties. Generally, the interest rates on ARMs are based on 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.

Most ARM programs feature a "cap" that protects borrowers from sudden monthly payment increases. Some ARMs can't adjust more than two percent per year, regardless of the underlying interest rate. Your loan may have a "payment cap" that instead of capping the interest rate directly, caps the amount that the monthly payment can increase in one period. The majority of ARMs also cap your rate over the life of the loan period.

ARMs usually start out at a very low rate that may increase over time. You've likely read about 5/1 or 3/1 ARMs. In these loans, the introductory 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 adjust. Loans like this are best for people who expect to move in three or five years. These types of adjustable rate loans are best for people who plan to move before the initial lock expires.

Most borrowers who choose ARMs do so because they want to take advantage of lower introductory rates and do not plan to stay in the house longer than the initial low-rate period. ARMs can be risky when property values decrease and borrowers cannot sell or refinance.

Have questions about mortgage loans? Call us at (512) 291-6100. We answer questions about different types of loans every day.

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