Differences between adjustable and fixed loans
A fixed-rate loan features a fixed payment for the entire duration of the loan. The property tax and homeowners insurance will increase over time, but in general, payments on fixed rate loans vary little.
During the early amortization period of a fixed-rate loan, a large percentage of your payment pays interest, and a much smaller part goes to principal. This proportion gradually 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 when interest rates are low and they want to lock in at the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can offer more stability in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'll be glad to assist you in locking a fixed-rate at the best rate currently available. Call Abundance Home Mortgage at (512) 335-7800 to discuss how we can help.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, the interest rates for ARMs are based on 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 ARMs are capped, so they won't go up above a certain amount in a given period of time. 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 a year, even if the index the rate is based on 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 payment can go up in a given period. Almost all ARMs also cap your rate over the life of the loan period.
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. It then adjusts every year. These loans are fixed for a certain number of years (3 or 5), then they adjust after the initial period. These loans are often best for borrowers who anticipate moving within three or five years. These types of adjustable rate loans are best for borrowers who plan to move before the loan adjusts.
You might choose an Adjustable Rate Mortgage to take advantage of a lower introductory interest rate and count on moving, refinancing or simply absorbing the higher rate after the introductory rate goes up. ARMs can be risky in a down market because homeowners can get stuck with rates that go up when they cannot 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.