Differences between fixed and adjustable rate loans
With a fixed-rate loan, your monthly payment remains the same for the life of the mortgage. The amount of the payment allocated to your principal (the actual loan amount) will increase, but the amount you pay in interest will decrease in the same amount. The property tax and homeowners insurance which are almost always part of the payment will go up over time, but for the most part, payment amounts on these types of loans don't increase much.
When you first take out a fixed-rate mortgage loan, most of the payment is applied to interest. That reverses itself as the loan ages.
Borrowers might choose a fixed-rate loan in order to lock in a low rate. People choose these types of loans when interest rates are low and they wish to lock in the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can provide more stability in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we'd love to assist you in locking a fixed-rate at a favorable rate. Call Signature Mortgage of Indiana at 812-945-4400 for details.
There are many different types of Adjustable Rate Mortgages. Generally, the interest on ARMs are based on an outside index. A few of these are: the 6-month Certificate of Deposit (CD) rate, the 1 year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
The majority of Adjustable Rate Mortgages are capped, so they won't increase over a certain amount in a given period. Some ARMs can't increase more than two percent per year, regardless of the underlying interest rate. Sometimes an ARM has a "payment cap" that guarantees your payment will not go above a certain amount in a given year. Almost all ARMs also cap your rate over the duration of the loan period.
ARMs usually start at a very low rate that usually increases over time. You may hear people talking about "3/1 ARMs" or "5/1 ARMs". For these loans, the initial rate is set for three or five years. After this period it adjusts every year. These loans are fixed for a certain number of years (3 or 5), then they adjust. Loans like this are best for borrowers who expect to move in three or five years. These types of adjustable rate programs most benefit borrowers who will 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 do not plan on staying in the house for any longer than this introductory low-rate period. ARMs are risky when property values go down and borrowers are unable to sell or refinance their loan.
Have questions about mortgage loans? Call us at 812-945-4400. We answer questions about different types of loans every day.