Differences between adjustable and fixed loans
With a fixed-rate loan, your payment stays the same for the life of the loan. The amount of the payment allocated for principal (the loan amount) goes up, but the amount you pay in interest will decrease in the same amount. The property tax and homeowners insurance will go up over time, but for the most part, payments on fixed rate loans vary little.
During the early amortization period of a fixed-rate loan, most of your payment goes toward interest, and a much smaller part toward principal. As you pay , more of your payment is applied to principal.
You can choose a fixed-rate loan in order to lock in a low interest rate. Borrowers choose fixed-rate loans when interest rates are low and they wish to lock in at the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can offer greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we'll be glad to help you lock in a fixed-rate at the best rate currently available. Call Channel Mortgage LLC at (718) 639-9500 to discuss how we can help.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, the interest for ARMs are determined by an outside index. Some examples of outside indexes are: the 6-month Certificate of Deposit (CD) rate, the 1 year rate on Treasure Securities, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
The majority of Adjustable Rate Mortgages are capped, so they can't increase over a specific amount in a given period of time. Some ARMs can't adjust more than 2% 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 the payment can go up in a given period. The majority of ARMs also cap your interest rate over the life of the loan period.
ARMs usually start at a very low rate that may increase as the loan ages. You may hear people talking about "3/1 ARMs" or "5/1 ARMs". For these loans, the initial rate is set for three or five years. It then adjusts every year. These types of loans are fixed for 3 or 5 years, then adjust after the initial period. These loans are often best for borrowers who anticipate moving in three or five years. These types of adjustable rate programs benefit people who will move before the loan adjusts.
You might choose an ARM to get a very low initial rate and plan on moving, refinancing or absorbing the higher rate after the initial rate expires. ARMs can be risky in a down market because homeowners can get stuck with increasing rates when they can't sell or refinance at the lower property value.
Have questions about mortgage loans? Call us at (718) 639-9500. It's our job to answer these questions and many others, so we're happy to help!