Differences between adjustable and fixed rate loans
With a fixed-rate loan, your payment doesn't change for the entire duration of your loan. The portion of the payment allocated to your principal (the actual loan amount) goes up, however, your interest payment will decrease accordingly. The property taxes and homeowners insurance which are almost always part of the payment will go up over time, but for the most part, payment amounts on fixed rate loans don't increase much.
Your first few years of payments on a fixed-rate loan go mostly toward interest. The amount applied to principal increases up slowly each month.
Borrowers can choose a fixed-rate loan in order to lock in a low interest rate. People choose these types of loans because interest rates are low and they wish to lock in at the lower rate. For homeowners who have an 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 the best rate currently available. Call VSI Home Lending at (260) 338-2561 to learn more.
There are many kinds of Adjustable Rate Mortgages. Generally, interest for ARMs are based on an outside index. A few of these are: the 6-month CD rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
The majority of ARMs feature this cap, so they won't go up above a certain amount in a given period of time. There may be a cap on interest rate variances over the course of a year. For example: no more than two 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 that the monthly payment can increase in a given period. The majority of ARMs also cap your rate over the life of the loan period.
ARMs usually start at a very low rate that may increase over time. 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. It then adjusts every year. These types of loans are fixed for 3 or 5 years, then adjust. Loans like this are best for people who anticipate moving in three or five years. These types of ARMs are best for people who plan to move before the initial lock expires.
Most borrowers who choose ARMs do so because they want to take advantage of lower introductory rates and don't plan on staying in the home longer than this introductory low-rate period. ARMs can be risky when housing prices go down because homeowners could be stuck with increasing rates if they cannot sell their home or refinance at the lower property value.
Have questions about mortgage loans? Call us at (260) 338-2561. We answer questions about different types of loans every day.