Differences between adjustable and fixed loans
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With a fixed-rate loan, your monthly payment never changes for the entire duration of your mortgage. The portion of the payment allocated to your principal (the loan amount) will go up, but the amount you pay in interest will go down accordingly. The property tax and homeowners insurance will go up over time, but in general, payments on fixed rate loans don't increase much.
During the early amortization period of a fixed-rate loan, most of your payment pays interest, and a much smaller percentage goes to principal. As you pay on the loan, more of your payment goes toward principal.
You can choose a fixed-rate loan to lock in a low interest rate. Borrowers choose fixed-rate loans when interest rates are low and they wish to lock in the low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can offer greater consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'd love to help you lock in a fixed-rate at the best rate currently available. Call Mortgage Max Corporation d/b/a Chicagoland Home Mortgage Services at 773-557-1000 to discuss how we can help.
There are many different kinds of Adjustable Rate Mortgages. Generally, the interest on ARMs are determined by a federal index. A few of these are: the 6-month CD rate, the 1 year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.
Most Adjustable Rate Mortgages are capped, so they won't go up over a specified amount in a given period. Some ARMs won't adjust more than two percent per year, regardless of the underlying interest rate. 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.
ARMs usually start out 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 introductory rate is set for three or five years. It then adjusts every year. These loans are fixed for 3 or 5 years, then they adjust. Loans like this are usually best for borrowers who expect to move within three or five years. These types of adjustable rate programs are best for borrowers who will move before the loan adjusts.
You might choose an ARM to take advantage of a lower introductory interest rate and count on moving, refinancing or absorbing the higher rate after the introductory rate goes up. ARMs are risky if property values decrease and borrowers cannot sell their home or refinance their loan.
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