Differences between adjustable and fixed rate loans
With a fixed-rate loan, your payment stays the same for the life of your mortgage. The portion that goes to your principal (the actual loan amount) increases, however, your interest payment will decrease in the same amount. The property tax and homeowners insurance which are almost always part of the payment will go up over time, but generally, payments on fixed rate loans vary little.
When you first take out a fixed-rate mortgage loan, most of the payment is applied to interest. The amount paid toward your principal amount increases up slowly every month.
You might choose a fixed-rate loan in order to lock in a low interest rate. People choose these types of loans when interest rates are low and they want to lock in the low rate. If you have an Adjustable Rate Mortgage (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 Omni Mortgage Company, Inc. at 603-893-6616 to learn more.
Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, interest rates for ARMs are based on an outside index. A few of these 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 ARMs are capped, so they can't increase above a specific 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 two percent a year, even if the index the rate is based on goes up by more than two percent. Your loan may have a "payment cap" that instead of capping the interest directly, caps the amount that your monthly payment can go up in a given period. Most ARMs also cap your interest rate over the life of the loan.
ARMs most often feature the lowest rates at the beginning. They usually guarantee the lower interest rate from a month to ten years. You've likely read about 5/1 or 3/1 ARMs. In these loans, the introductory rate is fixed for three or five years. After this period it adjusts every year. These types of loans are fixed for a number of years (3 or 5), then adjust. These loans are usually best for borrowers who anticipate moving in three or five years. These types of adjustable rate programs benefit people who will move before the initial lock expires.
You might choose an Adjustable Rate Mortgage to get a lower introductory rate and count on moving, refinancing or simply absorbing the higher rate after the initial rate goes up. ARMs are risky if property values go down and borrowers are unable to sell or refinance.
Have questions about mortgage loans? Call us at 603-893-6616. It's our job to answer these questions and many others, so we're happy to help!