Differences Between Adjustable and Fixed Rate Loans

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Fixed Rate Mortgage

With a fixed-rate loan, your monthly payment doesn’t change for the life of the mortgage. The portion of the payment allocated to your principal (the actual loan amount) will increase, but the amount you pay in interest will decrease over time, making your payment amount the same for the life of the loan. The property taxes and homeowners insurance will go up over time, but for the most part, payment amounts on fixed rate loans don’t increase that much due to these variables.

During the early amortization period of a fixed-rate loan, a large percentage of your monthly payment pays interest, and a significantly smaller percentage goes toward the principal. As you pay on the loan, more of your payment is applied to principal.

Borrowers might choose a fixed-rate loan to lock in a low rate. Borrowers choose fixed-rate loans when interest rates are low and they wish to lock in at a low rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can offer greater monthly payment stability. If you have an Adjustable Rate Mortgage (ARM) now, we’ll be glad to help you lock in a fixed-rate at the best rate currently available. Call Equiboxd Mortgage Inc. at (562) 584-4408 for details.

Adjustable Rate Mortgage

ARMs, as we called them above — come in many varieties. Generally, interest rates on ARMs are based on a federal index. A few of these are:

• 6-month CD rate
• 1 year Treasury Security rate
• Federal Home Loan Bank’s 11th District Cost of Funds Index (COFI)

The majority of Adjustable Rate Mortgages feature this cap, which means they won’t go up over a specific amount in a given period of time. There may be a cap on interest rate increases over the course of a year. For example: no more than a couple percent per year, even though the index the rate is based on increases by more than two percent. Sometimes an ARM has a “payment cap” that guarantees your payment can’t increase beyond a fixed amount over the course of a given year. Most ARMs also cap your rate over the life of the loan period.

Why Choose an ARM?

ARMs most often feature the lowest rates toward the start. They provide that rate from a month to ten years. You may hear people talking about “3/1 ARMs” or “5/1 ARMs”. In these loans, the initial rate is fixed for three or five years. It then adjusts every year. These types of loans are fixed for a certain number of years (3 or 5), then adjust after the initial period. These loans are usually best for borrowers who anticipate moving in three or five years. These types of ARMs are best for borrowers who will sell their house or refinance before the loan adjusts.

Most borrowers who choose ARMs do so because they want to get lower introductory rates and don’t plan on staying in the house for any longer than this introductory low-rate period. ARMs are risky if property values decrease and borrowers are unable to sell their home or refinance their loan.

When you’re ready to buy a home, it’s hard to know what your best options are financially. There’s a lot of information out there. Understanding it all can be challenging. We’re here to help, and can provide some answers to your mortgage questions. Acquiring a mortgage is a big step, and we’re helping people just like you reach their home-ownership dreams. Contact us today!