Fixed versus adjustable loans
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With a fixed-rate loan, your payment doesn't change for the entire duration of your loan. The amount of the payment that goes for principal (the actual loan amount) will go up, but the amount you pay in interest will go down accordingly. The property tax and homeowners insurance which are almost always part of the payment will increase over time, but in general, payment amounts on fixed rate loans change little over the life of the loan.
Early in a fixed-rate loan, a large percentage of your payment goes toward interest, and a much smaller part toward principal. As you pay on the loan, more of your payment goes toward principal.
You might choose a fixed-rate loan in order to lock in a low rate. Borrowers choose these types of loans because interest rates are low and they wish to lock in at this lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can provide greater stability in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), I'd love to assist you in locking a fixed-rate at a good rate. Call me at (619) 758-4035 to discuss how I can help.
Adjustable Rate Mortgages — ARMs, as we called them above — come in many varieties. ARMs usually adjust twice a year, based on various indexes.
Most programs have a "cap" that protects borrowers from sudden increases in monthly payments. Your ARM may feature a cap on how much your interest rate can increase in one period. For example: no more than two percent a year, even if the underlying index increases by more than two percent. 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. Additionally, the great majority of ARM programs have a "lifetime cap" — this means that your interest rate can't exceed the cap percentage.
ARMs usually start out at a very low rate that usually increases as the loan ages. 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. It then adjusts every year. These kinds of loans are fixed for a number of years (3 or 5), then adjust after the initial period. Loans like this are best for borrowers who expect to move in three or five years. These types of adjustable rate programs benefit borrowers who will move before the initial lock expires.
Most borrowers who choose ARMs do so when they want to take advantage of lower introductory rates and do not plan to remain in the home for any longer than the initial low-rate period. ARMs can be risky if property values go down and borrowers are unable to sell their home or refinance.
Have questions about mortgage loans? Call me at (619) 758-4035. I answer questions about different types of loans every day.