Differences between adjustable and fixed rate loans
A fixed-rate loan features the same payment amount for the entire duration of the mortgage. The property tax and homeowners insurance will increase over time, but in general, payments on fixed rate loans change little over the life of the loan.
During the early amortization period of a fixed-rate loan, most of your payment pays interest, and a significantly smaller part toward principal. This proportion reverses as the loan ages.
Borrowers might choose a fixed-rate loan to lock in a low interest rate. People choose these types of loans when interest rates are low and they want to lock in this low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can offer more 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 Equity Edge Mortgage, Inc. at 719-425-2226 to learn more.
There are many different types of Adjustable Rate Mortgages. Generally, interest for ARMs are determined by a federal index. A few of these are: the 6-month Certificate of Deposit (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 ARM programs have a "cap" that protects borrowers from sudden monthly payment increases. Your ARM may feature a cap on interest rate increases over the course of a year. For example: no more than a couple percent per year, even though the index the rate is based on increases 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 increase in a given period. Additionally, the great majority of ARMs have a "lifetime cap" — your interest rate can't exceed the capped percentage.
ARMs most often feature the lowest rates at the start of the loan. They usually guarantee that rate for an initial period that varies greatly. You may have heard 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 types of loans are fixed for a certain number of years (3 or 5), then adjust. Loans like this are best for people who anticipate moving within three or five years. These types of adjustable rate loans are best for people who will move before the loan adjusts.
Most borrowers who choose ARMs choose them because they want to take advantage of lower introductory rates and don't plan on staying in the house for any longer than this initial low-rate period. ARMs can be risky in a down market because homeowners could be stuck with rates that go up if they cannot sell their home or refinance with a lower property value.