Differences between adjustable and fixed rate loans
With a fixed-rate loan, your monthly payment never changes for the entire duration of the mortgage. The longer you pay, the more of your payment goes toward principal. The property taxes and homeowners insurance which are almost always part of the payment will go up over time, but for the most part, payments on these types of loans change little over the life of the loan.
During the early amortization period of a fixed-rate loan, most of your payment pays interest, and a significantly smaller part goes to principal. As you pay , more of your payment is applied to principal.
Borrowers might choose a fixed-rate loan to lock in a low rate. Borrowers 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 offer greater monthly payment stability. If you have an Adjustable Rate Mortgage (ARM) now, we'll be glad to help you lock in a fixed-rate at a good rate. Call America's Home Loans at 701.222.0100 to discuss your situation with one of our professionals.
Adjustable Rate Mortgages — ARMs, come in even more varieties. Generally, interest rates on ARMs are determined by a federal 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.
Most programs feature a cap that protects borrowers from sudden increases in monthly payments. Some ARMs can't increase more than two percent 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 that your monthly payment can go up in a given period. The majority of ARMs also cap your interest rate over the duration of the loan.
ARMs most often feature their lowest, most attractive rates at the beginning. They usually guarantee the lower interest rate for an initial period that varies greatly. You've likely read about 5/1 or 3/1 ARMs. For these loans, the initial rate is fixed for three or five years. After this period it adjusts every year. These types of loans are fixed for a certain number of years (3 or 5), then adjust after the initial period. These loans are usually best for borrowers who expect to move within three or five years. These types of adjustable rate loans are best for borrowers who will sell their house or refinance before the loan adjusts.
Most people who choose ARMs choose them when they want to get lower introductory rates and do not plan on staying in the house for any longer than the introductory low-rate period. ARMs are risky if property values go down and borrowers are unable to sell or refinance.
Have questions about mortgage loans? Call us at 701.222.0100. We answer questions about different types of loans every day.