Fixed versus adjustable rate loans
With a fixed-rate loan, your payment stays the same for the entire duration of the loan. The longer you pay, the more of your payment goes toward principal. Your property taxes may go up (or rarely, down), and so might the homeowner's insurance in your monthly payment. For the most part payment amounts on a fixed-rate loan will increase very little.
When you first take out a fixed-rate mortgage loan, most of your payment is applied to interest. This proportion gradually reverses as the loan ages.
Borrowers might choose a fixed-rate loan to lock in a low rate. Borrowers select 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 offer 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 Financial Edge Mortgage Corp. at 425-508-9988 to learn more.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, interest rates on ARMs are determined by an outside index. A few of these are: the 6-month Certificate of Deposit (CD) rate, the 1 year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most programs have a cap that protects you from sudden increases in monthly payments. Some ARMs can't adjust more than 2% per year, regardless of the underlying interest rate. Your loan may feature a "payment cap" that instead of capping the interest rate directly, caps the amount that the monthly payment can increase in a given period. Plus, almost all ARM programs have a "lifetime cap" — this means that the rate can't exceed the capped amount.
ARMs most often have their lowest, most attractive rates at the beginning. They guarantee the lower rate from a month to ten years. You may hear people talking about "3/1 ARMs" or "5/1 ARMs". In these loans, the initial rate is fixed 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 they adjust after the initial period. These loans are best for people who anticipate moving within three or five years. These types of adjustable rate loans are best for borrowers who will 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 expires. ARMs can be risky in a down market because homeowners can get stuck with increasing rates when they cannot sell their home or refinance at the lower property value.
Have questions about mortgage loans? Call us at 425-508-9988. We answer questions about different types of loans every day.