Differences between fixed and adjustable rate loans
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A fixed-rate loan features a fixed payment amount over the life of the loan. The property taxes and homeowners insurance will increase over time, but for the most part, payment amounts on these types of loans change little over the life of the loan.
During the early amortization period of a fixed-rate loan, most of your monthly payment goes toward interest, and a significantly smaller part toward principal. The amount paid toward principal increases up slowly every month.
You can choose a fixed-rate loan in order to lock in a low rate. Borrowers select these types of loans when interest rates are low and they want to lock in the low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can provide more consistency in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we'd love to assist you in locking a fixed-rate at a favorable rate. Call Mason Mortgage Advisors at (314) 395-8300 for details.
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. Some examples of outside indexes are: the 6-month Certificate of Deposit (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 have a cap that protects borrowers from sudden monthly payment increases. Some ARMs can't increase more than two percent per year, regardless of the underlying interest rate. Sometimes an ARM features a "payment cap" which guarantees that your payment can't increase beyond a certain amount over the course of a given year. Plus, the great majority of ARM programs feature a "lifetime cap" — this means that your rate won't exceed the capped percentage.
ARMs usually start at a very low rate that may increase over time. You've likely read about 5/1 or 3/1 ARMs. For these loans, the initial rate is fixed for three or five years. It then 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. These loans are usually best for borrowers who expect to move within three or five years. These types of adjustable rate programs most benefit borrowers who will sell their house or refinance before the loan adjusts.
You might choose an Adjustable Rate Mortgage to take advantage of a very low introductory interest rate and plan on moving, refinancing or simply absorbing the higher rate after the initial rate goes up. ARMs can be risky when property values go down and borrowers cannot sell or refinance.
Have questions about mortgage loans? Call us at (314) 395-8300. It's our job to answer these questions and many others, so we're happy to help!