Differences between adjustable and fixed rate loans
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With a fixed-rate loan, your payment remains the same for the entire duration of the mortgage. The longer you pay, the more of your payment goes toward principal. The property taxes and homeowners insurance which are almost always part of the payment will increase over time, but generally, payment amounts on fixed rate loans don't increase much.
Your first few years of payments on a fixed-rate loan are applied mostly toward interest. As you pay , more of your payment is applied to principal.
You can choose a fixed-rate loan to lock in a low rate. People select fixed-rate loans when interest rates are low and they want to lock in at the lower rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can offer greater 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 the best rate currently available. Call MGM Mortgage Company at (216) 524-8500 to learn more.
There are many different types of Adjustable Rate Mortgages. 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 Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most ARM programs feature a cap that protects borrowers from sudden increases in monthly payments. Your ARM may feature a cap on interest rate increases over the course of a year. For example: no more than a couple percent per 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 the payment can increase in one period. Most ARMs also cap your interest rate over the duration of the loan period.
ARMs most often feature the lowest rates at the start of the loan. They usually guarantee the lower interest rate for an initial period that varies greatly. You've probably read about 5/1 or 3/1 ARMs. For these loans, the initial rate is set for three or five years. After this period it adjusts every year. These loans are fixed for a certain number of years (3 or 5), then they adjust after the initial period. Loans like this are usually best for people who expect to move within three or five years. These types of adjustable rate loans are best for people who will move before the loan adjusts.
You might choose an Adjustable Rate Mortgage to get a lower initial interest rate and plan on moving, refinancing or simply absorbing the higher rate after the initial rate goes up. ARMs can be risky when housing prices go down because homeowners could be stuck with rates that go up when they cannot sell or refinance at the lower property value.
Have questions about mortgage loans? Call us at (216) 524-8500. We answer questions about different types of loans every day.