Differences between adjustable and fixed rate loans
A fixed-rate loan features the same payment amount for the entire duration of the loan. The property taxes and homeowners insurance which are almost always part of the payment will go up over time, but generally, payments on fixed rate loans don't increase much.
At the beginning of a a fixed-rate loan, the majority the payment goes toward interest. As you pay on the loan, more of your payment goes toward principal.
You might choose a fixed-rate loan to lock in a low interest rate. Borrowers choose fixed-rate loans when interest rates are low and they want to lock in the low rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can offer more consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we can help you lock in a fixed-rate at a good rate. Call Contemporary Mortgage Services, Inc at 407-834-3377 to learn more.
Adjustable Rate Mortgages — ARMs, as we called them above — come in many varieties. Generally, the interest on ARMs are based on 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 Adjustable Rate Mortgages are capped, which means they can't increase above a certain amount in a given period. Some ARMs won'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 payment can increase in one period. Most ARMs also cap your interest rate over the duration of the loan.
ARMs most often have their lowest rates at the beginning of the loan. They provide that interest rate for an initial period that varies greatly. You've likely heard of 5/1 or 3/1 ARMs. In these loans, the introductory rate is fixed for three or five years. It then adjusts every year. These loans are fixed for a number of years (3 or 5), then adjust. Loans like this are best for people who expect to move in three or five years. These types of ARMs most benefit people who will move before the loan adjusts.
You might choose an Adjustable Rate Mortgage to get a lower initial rate and count on moving, refinancing or absorbing the higher rate after the introductory rate expires. ARMs can be risky when housing prices go down because homeowners can get stuck with increasing rates if they can't sell their home or refinance with a lower property value.
Have questions about mortgage loans? Call us at 407-834-3377. It's our job to answer these questions and many others, so we're happy to help!