Differences between fixed and adjustable loans
With a fixed-rate loan, your payment doesn't change for the entire duration of your mortgage. The portion that goes to principal (the amount you borrowed) will go up, however, your interest payment will decrease in the same amount. Your property taxes may go up (or rarely, down), and your insurance rates might vary as well. But generally payments on your fixed-rate loan will be very stable.
Early in a fixed-rate loan, most of your monthly payment pays interest, and a much smaller percentage toward principal. As you pay , more of your payment is applied to principal.
Borrowers can choose a fixed-rate loan to lock in a low interest rate. People choose fixed-rate loans because interest rates are low and they want to lock in this lower rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can provide greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we can help you lock in a fixed-rate at the best rate currently available. Call Commonwealth Mortgage & Investments, Inc. at 804-768-9519 to learn more.
There are many different types of Adjustable Rate Mortgages. ARMs usually adjust twice a year, based on various indexes.
Most Adjustable Rate Mortgages are capped, which means they won't increase above a specific amount in a given period of time. Your ARM may feature a cap on interest rate increases over the course of a year. For example: no more than two percent a year, even if the underlying index goes up by more than two percent. Your loan may feature a "payment cap" that instead of capping the interest rate directly, caps the amount the monthly payment can increase in one period. Plus, almost all ARMs feature a "lifetime cap" — this cap means that the interest rate can't go over the capped percentage.
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". For these loans, the introductory rate is fixed for three or five years. After this period it adjusts every year. These loans are fixed for 3 or 5 years, then they adjust. Loans like this are often best for borrowers who anticipate moving within three or five years. These types of adjustable rate loans benefit people who will sell their house or refinance before the initial lock expires.
You might choose an ARM to take advantage of a lower introductory interest rate and plan on moving, refinancing or absorbing the higher rate after the initial rate goes up. ARMs can be risky in a down market because homeowners could be stuck with rates that go up when they can't sell or refinance at the lower property value.