Differences between adjustable and fixed rate loans
With a fixed-rate loan, your payment remains the same for the entire duration of the mortgage. The amount allocated for your principal (the actual loan amount) will go up, however, your interest payment will go down in the same amount. The property tax and homeowners insurance which are almost always part of the payment will increase over time, but in general, payment amounts on these types of loans don't increase much.
Your first few years of payments on a fixed-rate loan go primarily to pay interest. The amount applied to principal goes up slowly every month.
Borrowers can choose a fixed-rate loan in order to lock in a low interest rate. Borrowers choose these types of loans because interest rates are low and they wish to lock in this lower rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can provide greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we can help you lock in a fixed-rate at the best rate currently available. Call Lake Area Mortgage at 651-209-2900 to discuss how we can help.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, the interest for ARMs are determined by 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.
The majority of Adjustable Rate Mortgages feature this cap, so they won't go up above a certain amount in a given period of time. Some ARMs won't increase more than 2% per year, regardless of the underlying interest rate. Sometimes an ARM has a "payment cap" that ensures that your payment can't go above a fixed amount in a given year. Additionally, the great majority of ARMs feature a "lifetime cap" — this cap means that your rate can't ever go over the cap amount.
ARMs usually start at a very low rate that usually increases over time. You've probably read about 5/1 or 3/1 ARMs. In these loans, the initial rate is fixed for three or five years. After this period it adjusts every year. These kinds of loans are fixed for a number of years (3 or 5), then adjust. Loans like this are usually best for borrowers who expect to move in three or five years. These types of ARMs most benefit people who will move before the initial lock expires.
You might choose an ARM to get a lower initial 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 could be stuck with rates that go up if they can't sell their home or refinance at the lower property value.