Fixed versus adjustable rate loans
With a fixed-rate loan, your payment never changes for the entire duration of your mortgage. The portion of the payment allocated for your principal (the loan amount) will go up, however, the amount you pay in interest will go down in the same amount. Your property taxes may go up (or rarely, down), and so might the homeowner's insurance in your monthly payment. For the most part payments for your fixed-rate mortgage will be very stable.
Early in a fixed-rate loan, most of your monthly payment goes toward interest, and a significantly smaller part goes to principal. As you pay , more of your payment is applied to principal.
You might choose a fixed-rate loan to lock in a low rate. Borrowers choose fixed-rate loans because interest rates are low and they want to lock in at this low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing into a fixed-rate loan can provide more stability in monthly payments. If you currently have an Adjustable Rate Mortgage (ARM), we'd love to help you lock in a fixed-rate at a good rate. Call Strategic Mortgage, LLC at 812-989-9358 for details.
Adjustable Rate Mortgages — ARMs, come in even more varieties. Generally, the interest on ARMs are determined by a federal index. A few of these are: the 6-month 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 can't increase over a specific amount in a given period of time. There may be a cap on how much your interest rate can go up in one period. For example: no more than a couple percent per year, even if the underlying index goes up by more than two percent. Sometimes an ARM features a "payment cap" which guarantees that your payment won't go above a certain amount over the course of a given year. The majority of ARMs also cap your interest rate over the duration of the loan period.
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". In these loans, the initial 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 usually best for people who anticipate moving in three or five years. These types of adjustable rate loans are best for borrowers who plan to move before the loan adjusts.
You might choose an Adjustable Rate Mortgage to get a lower introductory rate and plan on moving, refinancing or simply absorbing the higher rate after the introductory rate goes up. ARMs are risky if property values go down and borrowers can't sell their home or refinance their loan.
Have questions about mortgage loans? Call us at 812-989-9358. We answer questions about different types of loans every day.