Fixed versus adjustable rate loans
With a fixed-rate loan, your monthly payment doesn't change for the entire duration of your loan. The portion of the payment that goes for principal (the loan amount) goes up, however, the amount you pay in interest 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. But generally payment amounts for a fixed-rate loan will be very stable.
Your first few years of payments on a fixed-rate loan are applied mostly to pay interest. As you pay , more of your payment is applied to principal.
Borrowers might choose a fixed-rate loan to lock in a low rate. People choose these types of loans because interest rates are low and they want to lock in at the lower rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can provide greater consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to help you lock in a fixed-rate at the best rate currently available. Call The Mortgage Exchange Service LLC at 703.255-5810 for details.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, interest for ARMs are determined by a federal index. A few of these are: the 6-month CD rate, the 1 year Treasury Security rate, 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 increases in monthly payments. Some ARMs can't increase 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 the monthly payment can increase in one period. Almost all ARMs also cap your rate over the life of the loan.
ARMs most often have the lowest, most attractive rates toward the beginning of the loan. They usually guarantee the lower rate for an initial period that varies greatly. You may have heard about "3/1 ARMs" or "5/1 ARMs". For these loans, the initial rate is set for three or five years. It then adjusts every year. These kinds of loans are fixed for 3 or 5 years, then they adjust. These loans are best for people who anticipate moving in three or five years. These types of ARMs are best for borrowers who plan to sell their house or refinance before the initial lock expires.
Most people who choose ARMs choose them when they want to get lower introductory rates and don't plan to remain in the house longer than the initial low-rate period. ARMs can be risky when property values decrease and borrowers are unable to sell or refinance.
Have questions about mortgage loans? Call us at 703.255-5810. We answer questions about different types of loans every day.