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 portion of the payment allocated for your principal (the amount you borrowed) will go up, however, the amount you pay in interest will go down in the same amount. The property tax and homeowners insurance which are almost always part of the payment will increase over time, but in general, payments on these types of loans don't increase much.
Your first few years of payments on a fixed-rate loan go mostly to pay interest. The amount applied to principal increases up gradually every month.
You might choose a fixed-rate loan to lock in a low rate. People select these types of loans when interest rates are low and they want to lock in at this low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can offer greater stability in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we'll be glad to help you lock in a fixed-rate at a favorable rate. Call Firelight Mortgage Consultants at (303) 228-2254 to discuss your situation with one of our professionals.
There are many kinds of Adjustable Rate Mortgages. Generally, the interest rates for ARMs are based on a federal index. A few of these are: the 6-month CD rate, the 1 year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most ARMs are capped, so they can't increase above a certain amount in a given period of time. Some ARMs can't increase more than two percent per year, regardless of the underlying interest rate. Your loan may have a "payment cap" that instead of capping the interest directly, caps the amount your monthly payment can go up in a given period. Most ARMs also cap your interest rate over the life of the loan period.
ARMs usually start out at a very low rate that may increase over time. You may have heard about "3/1 ARMs" or "5/1 ARMs". In these loans, the introductory rate is set for three or five years. It then adjusts every year. These loans are fixed for 3 or 5 years, then they 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 ARM to take advantage of a very low initial interest rate and count on moving, refinancing or absorbing the higher rate after the initial rate goes up. ARMs are risky if property values decrease and borrowers are unable to sell or refinance.
Have questions about mortgage loans? Call us at (303) 228-2254. We answer questions about different types of loans every day.