Differences between adjustable and fixed rate loans
With a fixed-rate loan, your payment stays the same for the entire duration of the mortgage. The amount of the payment that goes for principal (the loan amount) will go up, but the amount you pay in interest will go down accordingly. Your property taxes may go up (or rarely, down), and your insurance rates might vary as well. But generally payments for your fixed-rate loan will be very stable.
During the early amortization period of a fixed-rate loan, a large percentage of your monthly payment goes toward interest, and a much smaller part toward principal. The amount applied to principal goes up slowly each month.
Borrowers can choose a fixed-rate loan to lock in a low rate. Borrowers select these types of loans when interest rates are low and they wish to lock in the low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with 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 the best rate currently available. Call Northeast Bancorp of America, Inc. at (440) 234-9660 to discuss how we can help.
There are many kinds of Adjustable Rate Mortgages. Generally, interest rates on ARMs are based on a federal index. A few of these are: the 6-month 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 ARMs are capped, so they won't go up above a certain amount in a given period of time. There may be a cap on how much your interest rate can increase in one period. For example: no more than a couple percent a year, even though the underlying index increases by more than two percent. Your loan may feature a "payment cap" that instead of capping the interest rate directly, caps the amount the payment can increase in a given period. The majority of ARMs also cap your interest rate over the duration of the loan.
ARMs usually start out at a very low rate that usually increases as the loan ages. You may have heard about "3/1 ARMs" or "5/1 ARMs". For these loans, the initial rate is set for three or five years. After this period it adjusts every year. These loans are fixed for a number of years (3 or 5), then they adjust. These loans are usually best for borrowers who anticipate moving in three or five years. These types of adjustable rate loans benefit borrowers who will sell their house or refinance before the initial lock expires.
Most people who choose ARMs choose them when they want to take advantage of lower introductory rates and don't plan on staying in the house for any longer than this initial low-rate period. ARMs are risky if property values decrease and borrowers can't sell or refinance their loan.
Have questions about mortgage loans? Call us at (440) 234-9660. It's our job to answer these questions and many others, so we're happy to help!