Differences between fixed and adjustable rate loans
A fixed-rate loan features the same payment over the life of the loan. The property taxes and homeowners insurance will increase over time, but in general, payment amounts on these types of loans vary little.
During the early amortization period of a fixed-rate loan, most of your payment goes toward interest, and a significantly smaller percentage goes to principal. As you pay , more of your payment is applied to principal.
You can choose a fixed-rate loan in order to lock in a low rate. Borrowers choose these types of loans because interest rates are low and they want to lock in this lower rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can offer greater stability in monthly payments. 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 Reliance Mortgage Service, Inc at 562 320-0510 to learn more.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, 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 rate on Treasure Securities, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most programs feature a cap that protects you from sudden increases in monthly payments. There may be a cap on interest rate variances over the course of a year. For example: no more than a couple percent per year, even if the index the rate is based on increases by more than two percent. Your loan may have a "payment cap" that instead of capping the interest rate directly, caps the amount the monthly payment can increase in a given period. The majority of ARMs also cap your interest rate over the duration of the loan.
ARMs most often have the lowest, most attractive rates toward the start. They provide that rate for an initial period that varies greatly. 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 types of loans are fixed for 3 or 5 years, then they adjust after the initial period. Loans like this are often best for people who expect to move within three or five years. These types of adjustable rate loans benefit borrowers who will sell their house or refinance before the initial lock expires.
You might choose an ARM to take advantage of a lower introductory interest rate and count on moving, refinancing or absorbing the higher rate after the initial rate expires. ARMs can be risky if property values decrease and borrowers can't sell their home or refinance their loan.
Have questions about mortgage loans? Call us at 562 320-0510. We answer questions about different types of loans every day.