Fixed versus adjustable rate loans
With a fixed-rate loan, your payment never changes for the life of the mortgage. The portion allocated for principal (the amount you borrowed) will increase, however, the amount you pay in interest will decrease in the same amount. Your property taxes increase, or rarely, decrease, and your insurance rates might vary as well. But generally monthly payments for your fixed-rate loan will be very stable.
Your first few years of payments on a fixed-rate loan go mostly to pay interest. The amount paid toward your principal amount goes up slowly each month.
Borrowers can choose a fixed-rate loan to lock in a low interest rate. People choose these types of loans when interest rates are low and they want to lock in at this low rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can offer more consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to assist you in locking a fixed-rate at a favorable rate. Call Northeast Bancorp of America, Inc. at (440) 234-9660 to learn more.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, the interest rates for ARMs are based on an outside index. A few of these 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.
The majority of ARMs feature this cap, so they won't increase over a specified amount in a given period of time. 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 your monthly payment can go up in a given period. Most ARMs also cap your interest rate over the duration of the loan period.
ARMs most often feature their lowest rates at the beginning of the loan. They usually guarantee that interest rate from a month to ten years. You've likely heard of 5/1 or 3/1 ARMs. For these loans, the initial 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 after the initial period. These loans are best for people who expect to move within three or five years. These types of adjustable rate programs benefit borrowers who plan to sell their house or refinance before the loan adjusts.
You might choose an Adjustable Rate Mortgage to take advantage of a very low initial interest rate and count on moving, refinancing or simply absorbing the higher rate after the introductory rate expires. ARMs can be risky in a down market because homeowners can get stuck with increasing rates if they can't sell or refinance with a lower property value.
Have questions about mortgage loans? Call us at (440) 234-9660. We answer questions about different types of loans every day.