Fixed versus adjustable rate loans
With a fixed-rate loan, your monthly payment never changes for the entire duration of your loan. The portion that goes for principal (the actual loan amount) will go up, but your interest payment will decrease accordingly. Your property taxes increase, or rarely, decrease, and so might the homeowner's insurance in your monthly payment. But generally payments for your fixed-rate loan will be very stable.
Your first few years of payments on a fixed-rate loan are applied mostly to pay interest. As you pay on the loan, more of your payment goes toward principal.
You can choose a fixed-rate loan in order to lock in a low interest rate. People select these types of loans when interest rates are low and they wish to lock in this low rate. For homeowners who have an 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'll be glad to help you lock in a fixed-rate at a favorable rate. Call Northeast Bancorp of America, Inc. at (440) 234-9660 for details.
Adjustable Rate Mortgages — ARMs, as we called them above — come in a great number of varieties. Generally, interest rates on ARMs are determined by a federal index. Some examples of outside indexes are: the 6-month Certificate of Deposit (CD) rate, the one-year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most ARM programs have a "cap" that protects you from sudden monthly payment increases. Some ARMs won't adjust 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 rate directly, caps the amount that the monthly payment can increase in a given period. Plus, the great majority of ARM programs have a "lifetime cap" — your interest rate can't go over the capped percentage.
ARMs usually start 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 introductory 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 within three or five years. These types of adjustable rate loans are best for borrowers who will move before the loan adjusts.
You might choose an Adjustable Rate Mortgage to take advantage of a lower initial interest rate and plan on moving, refinancing or absorbing the higher rate after the introductory rate goes up. ARMs can be risky when housing prices go down because homeowners could be stuck with rates that go up if they can't sell or refinance at the lower property value.
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!