Fixed versus adjustable loans
With a fixed-rate loan, your payment doesn't change for the entire duration of your mortgage. The amount of the payment that goes to principal (the loan amount) will go up, however, the amount you pay in interest will go down accordingly. The property tax and homeowners insurance will go up over time, but generally, payment amounts on fixed rate loans vary little.
When you first take out a fixed-rate mortgage loan, the majority the payment goes toward interest. As you pay on the loan, more of your payment goes toward principal.
Borrowers can choose a fixed-rate loan to lock in a low rate. People select fixed-rate loans because interest rates are low and they wish to lock in this lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can provide more monthly payment stability. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to assist you in locking a fixed-rate at a favorable rate. Call Abundance Home Mortgage at (512) 335-7800 to discuss how we can help.
There are many types of Adjustable Rate Mortgages. Generally, the interest rates for ARMs are based on an outside index. A few of these are: the 6-month CD rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most programs feature a "cap" that protects borrowers from sudden increases in monthly payments. Some ARMs can't adjust more than two percent per year, regardless of the underlying interest rate. Your loan may feature a "payment cap" that instead of capping the interest directly, caps the amount the payment can increase in a given period. Additionally, the great majority of ARMs have a "lifetime cap" — this means that your rate can never exceed the capped percentage.
ARMs most often have their lowest rates at the beginning. They guarantee that rate from a month to ten years. You may hear people talking about "3/1 ARMs" or "5/1 ARMs". For these loans, the initial rate is set for three or five years. It then adjusts every year. These loans are fixed for 3 or 5 years, then adjust after the initial period. Loans like this are best for borrowers who expect to move within three or five years. These types of adjustable rate programs are best for borrowers who will sell their house or refinance before the loan adjusts.
Most borrowers who choose ARMs do so when they want to get lower introductory rates and do not plan to stay in the house longer than this introductory low-rate period. ARMs can be risky when housing prices go down because homeowners could be stuck with increasing rates when they can't sell their home or refinance at the lower property value.
Have questions about mortgage loans? Call us at (512) 335-7800. We answer questions about different types of loans every day.