Differences between adjustable and fixed loans
With a fixed-rate loan, your payment never changes for the entire duration of the mortgage. The portion of the payment allocated to your principal (the loan amount) increases, however, your interest payment will go down in the same amount. Your property taxes increase, or rarely, decrease, and so might the homeowner's insurance in your monthly payment. For the most part payment amounts for a fixed-rate mortgage will increase very little.
During the early amortization period of a fixed-rate loan, most of your payment pays interest, and a significantly smaller part goes to principal. The amount applied to principal goes up gradually each month.
Borrowers might choose a fixed-rate loan in order to lock in a low interest rate. People select fixed-rate loans when interest rates are low and they want to lock in at this lower rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can provide more monthly payment stability. If you have an Adjustable Rate Mortgage (ARM) now, we'll be glad to help you lock in a fixed-rate at a favorable rate. Call Saab Mortgage at 703-288-0777 to discuss your situation with one of our professionals.
Adjustable Rate Mortgages — ARMs, as we called them above — come in many varieties. Generally, the interest on ARMs are determined by a federal index. Some examples of outside indexes 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 programs feature a cap that protects you from sudden increases in monthly payments. Some ARMs won't increase more than 2% per year, regardless of the underlying interest rate. Sometimes an ARM features a "payment cap" that ensures your payment won't increase beyond a fixed amount over the course of a given year. The majority of ARMs also cap your interest rate over the life of the loan period.
ARMs usually start 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". In these loans, the introductory rate is fixed for three or five years. After this period it adjusts every year. These types of loans are fixed for 3 or 5 years, then adjust after the initial period. Loans like this are best for borrowers who expect to move within three or five years. These types of adjustable rate loans benefit people who plan to sell their house or refinance before the loan adjusts.
Most people who choose ARMs do so because they want to take advantage of lower introductory rates and don't plan on remaining in the house for any longer than this introductory low-rate period. 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 703-288-0777. We answer questions about different types of loans every day.