Differences between adjustable and fixed loans

A fixed-rate loan features a fixed payment for the entire duration of the mortgage. The property tax and homeowners insurance will go up over time, but for the most part, payments on these types of loans change little over the life of the loan.

During the early amortization period of a fixed-rate loan, a large percentage of your monthly payment pays interest, and a much smaller percentage goes to principal. As you pay on the loan, more of your payment goes toward principal.

Borrowers might choose a fixed-rate loan to lock in a low interest rate. Borrowers select these types of loans because interest rates are low and they want to lock in at this low rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can offer more monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we'll be glad to help you lock in a fixed-rate at the best rate currently available. Call Equity Edge Mortgage, Inc. at 719-425-2226 for details.

Adjustable Rate Mortgages — ARMs, as we called them above — come in many varieties. Generally, interest on ARMs are determined by an outside index. A few of these are: the 6-month CD rate, the one-year rate on Treasure Securities, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.

Most ARM programs feature a "cap" that protects borrowers 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 your payment can go up in one period. Additionally, almost all ARM programs have a "lifetime cap" — your interest rate won't go over the capped amount.

ARMs most often feature their lowest rates at the start of the loan. They usually guarantee the lower rate for an initial period that varies greatly. 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 kinds of loans are fixed for a certain number of years (3 or 5), then they adjust after the initial period. Loans like this are best for people who expect to move in three or five years. These types of adjustable rate loans benefit borrowers who will sell their house or refinance before the loan adjusts.

Most borrowers who choose ARMs choose them when they want to take advantage of lower introductory rates and do not plan to remain in the home for any longer than this initial low-rate period. ARMs can be risky in a down market because homeowners could be 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 719-425-2226. We answer questions about different types of loans every day.