Fixed versus adjustable loans
With a fixed-rate loan, your monthly payment never changes for the entire duration of the loan. The amount of the payment that goes for principal (the amount you borrowed) will go up, however, your interest payment will go down accordingly. The property taxes and homeowners insurance will increase over time, but generally, payment amounts on these types of loans don't increase much.
During the early amortization period of a fixed-rate loan, most of your monthly payment pays interest, and a significantly smaller part goes to principal. The amount paid toward principal increases up slowly every month.
Borrowers might choose a fixed-rate loan to lock in a low interest rate. Borrowers choose these types of loans when interest rates are low and they want to lock in the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can provide greater consistency in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we can assist you in locking a fixed-rate at the best rate currently available. Call Abundance Home Mortgage at (512) 335-7800 for details.
Adjustable Rate Mortgages — ARMs, as we called them above — come in a great number of varieties. Generally, interest rates for ARMs are determined by an outside 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 programs have a cap that protects borrowers from sudden increases in monthly payments. There may be a cap on how much your interest rate can go up in one period. For example: no more than a couple percent per year, even though the underlying index goes up by more than two percent. Your loan may have a "payment cap" that instead of capping the interest rate directly, caps the amount your monthly payment can increase in a given period. In addition, the great majority of ARM programs feature a "lifetime cap" — the interest rate will never go over the capped amount.
ARMs most often feature the lowest rates toward the start of the loan. They provide that rate for an initial period that varies greatly. You've likely read about 5/1 or 3/1 ARMs. For these loans, the introductory rate is set for three or five years. After this period it adjusts every year. These loans are fixed for a certain number of years (3 or 5), then adjust. These loans are usually best for borrowers who anticipate moving in three or five years. These types of adjustable rate loans benefit people who will move before the loan adjusts.
Most borrowers who choose ARMs choose them because they want to get lower introductory rates and don't plan on staying in the home for any longer than this initial low-rate period. ARMs can be risky when housing prices go down because homeowners can get stuck with increasing rates if they can't sell their home or refinance with a lower property value.
Have questions about mortgage loans? Call us at (512) 335-7800. It's our job to answer these questions and many others, so we're happy to help!