Differences between adjustable and fixed rate loans
With a fixed-rate loan, your payment remains the same for the entire duration of your mortgage. The longer you pay, the more of your payment goes toward principal. The property tax and homeowners insurance will go up 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 much smaller percentage goes to principal. The amount applied to principal goes up slowly each month.
Borrowers can choose a fixed-rate loan to lock in a low rate. Borrowers choose these types of loans because interest rates are low and they want to lock in the low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can provide greater stability in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we can help you lock in a fixed-rate at a favorable rate. Call Southwest Funding #841 at (512) 291-6100 to learn more.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, interest on ARMs are determined by a federal index. A few of these are: the 6-month Certificate of Deposit (CD) rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most ARMs are capped, which means they won't go up over a specific amount in a given period. Your ARM may feature a cap on interest rate variances over the course of a year. For example: no more than two percent per year, even if the index the rate is based on increases by more than two percent. Your loan may feature a "payment cap" that instead of capping the interest directly, caps the amount that your payment can go up in one period. In addition, the great majority of ARMs have a "lifetime cap" — this cap means that your interest rate can't go over the capped percentage.
ARMs usually start out at a very low rate that may increase as the loan ages. 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 borrowers who expect to move within three or five years. These types of ARMs most benefit borrowers who plan to sell their house or refinance before the loan adjusts.
Most people who choose ARMs do so because they want to take advantage of lower introductory rates and don't plan on staying in the home for any longer than the initial low-rate period. ARMs can be risky in a down market because homeowners can get stuck with rates that go up when they can't sell their home or refinance at the lower property value.
Have questions about mortgage loans? Call us at (512) 291-6100. We answer questions about different types of loans every day.