Differences between adjustable and fixed rate loans
With a fixed-rate loan, your monthly payment doesn't change for the entire duration of the loan. The longer you pay, the more of your payment goes toward principal. The property tax and homeowners insurance which are almost always part of the payment will go up over time, but in general, payments on these types of loans don't increase much.
During the early amortization period of a fixed-rate loan, most of your monthly payment pays interest, and a significantly smaller part toward principal. As you pay , more of your payment is applied to principal.
Borrowers can choose a fixed-rate loan in order to lock in a low rate. People select these types of loans when interest rates are low and they wish to lock in at this low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can offer more consistency in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we'd love to help you lock in a fixed-rate at the best rate currently available. Call Executive Lending Group, LLC at (816) 525-8000 to discuss how we can help.
There are many different types of Adjustable Rate Mortgages. Generally, the interest for ARMs are based on an outside index. Some examples of outside indexes are: the 6-month Certificate of Deposit (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 are capped, so they won't increase above a certain amount in a given period of time. Some ARMs can't increase more than 2% per year, regardless of the underlying interest rate. Sometimes an ARM features a "payment cap" which guarantees that your payment won't increase beyond a certain amount over the course of a given year. In addition, the great majority of adjustable programs have a "lifetime cap" — this means that your interest rate can never go over the capped amount.
ARMs usually start out at a very low rate that usually increases over time. You may have heard about "3/1 ARMs" or "5/1 ARMs". For these loans, the initial rate is fixed for three or five years. After this period it adjusts every year. These loans are fixed for a number of years (3 or 5), then adjust. These loans are best for people who anticipate moving in three or five years. These types of ARMs most benefit people 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 on remaining in the house for any longer than the initial low-rate period. ARMs are risky when property values decrease and borrowers can't sell their home or refinance.
Have questions about mortgage loans? Call us at (816) 525-8000. We answer questions about different types of loans every day.