Fixed versus adjustable rate loans
A fixed-rate loan features the same payment for the entire duration of the mortgage. The property taxes and homeowners insurance which are almost always part of the payment will increase over time, but for the most part, payment amounts on fixed rate loans don't increase much.
Your first few years of payments on a fixed-rate loan go mostly toward interest. The amount applied to principal goes up slowly each month.
You can choose a fixed-rate loan in order to lock in a low rate. Borrowers select fixed-rate loans when interest rates are low and they wish to lock in this lower rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can provide more stability in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to help you lock in a fixed-rate at a favorable rate. Call Great Mortgage NMLS#478647 at 708.966.9005 to discuss your situation with one of our professionals.
Adjustable Rate Mortgages — ARMs, come in a great number of varieties. Generally, interest rates on ARMs are determined by 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 ARMs are capped, so they can't go up above a specific amount in a given period of time. Some ARMs won't adjust more than 2% per year, regardless of the underlying interest rate. Sometimes an ARM has a "payment cap" which ensures that your payment will not go above a fixed amount over the course of a given year. Plus, almost all ARM programs have a "lifetime cap" — the rate can't go over the capped amount.
ARMs most often have the lowest rates at the start of the loan. They usually guarantee the lower interest rate for an initial period that varies greatly. You may have heard about "3/1 ARMs" or "5/1 ARMs". For these loans, the introductory rate is set for three or five years. After this period it adjusts every year. These kinds of loans are fixed for 3 or 5 years, then they adjust after the initial period. Loans like this are best for people who expect to move in three or five years. These types of adjustable rate programs benefit people who will move before the loan adjusts.
You might choose an ARM to take advantage of a lower initial interest rate and plan on moving, refinancing or simply absorbing the higher rate after the initial rate expires. ARMs can be risky when housing prices go down because homeowners can get stuck with rates that go up if they can't sell their home or refinance at the lower property value.
Have questions about mortgage loans? Call us at 708.966.9005. It's our job to answer these questions and many others, so we're happy to help!