Differences between adjustable and fixed rate loans
With a fixed-rate loan, your payment remains the same for the life of your mortgage. The longer you pay, the more of your payment goes toward principal. The property taxes and homeowners insurance will go up over time, but in general, payments on these types of loans vary little.
During the early amortization period of a fixed-rate loan, a large percentage of your payment pays interest, and a significantly smaller part goes to principal. As you pay , more of your payment goes toward principal.
You can choose a fixed-rate loan to lock in a low rate. People select these types of loans because interest rates are low and they want to lock in at the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can offer greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we'd love to assist you in locking a fixed-rate at the best rate currently available. Call MS Investment Mortgage Company at (858) 485-5800 to discuss how we can help.
There are many different types of Adjustable Rate Mortgages. Generally, interest for ARMs are determined by a federal index. Some examples of outside indexes are: the 6-month Certificate of Deposit (CD) rate, the 1 year rate on Treasure Securities, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most programs have a "cap" that protects you from sudden increases in monthly payments. Your ARM may feature a cap on interest rate increases over the course of a year. For example: no more than a couple percent a year, even though the underlying index increases by more than two percent. Sometimes an ARM features a "payment cap" that ensures that your payment will not increase beyond a fixed amount over the course of a given year. Additionally, the great majority of ARMs feature a "lifetime cap" — this cap means that the rate can't ever go over the cap amount.
ARMs usually start at a very low rate that may increase over time. You've probably read about 5/1 or 3/1 ARMs. For these loans, the introductory 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 they adjust after the initial period. These loans are often best for people who expect to move in three or five years. These types of adjustable rate programs most benefit people who will move before the initial lock expires.
You might choose an Adjustable Rate Mortgage to get a lower initial rate and plan on moving, refinancing or simply absorbing the higher rate after the introductory rate expires. ARMs can be risky in a down market because homeowners could be stuck with rates that go up when they can't sell their home or refinance with a lower property value.