Fixed versus adjustable rate loans
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With a fixed-rate loan, your monthly payment remains the same for the life of your mortgage. The portion that goes to your principal (the amount you borrowed) goes up, but your interest payment will decrease accordingly. The property taxes and homeowners insurance which are almost always part of the payment will go up over time, but generally, payment amounts on fixed rate loans don't increase much.
When you first take out a fixed-rate mortgage loan, most of the payment is applied to interest. That gradually reverses itself as the loan ages.
Borrowers can choose a fixed-rate loan in order to lock in a low rate. Borrowers choose fixed-rate loans when interest rates are low and they wish to lock in this low rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can offer greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we can help you lock in a fixed-rate at a favorable rate. Call Essential Mortgage at (504) 888-3858 to learn more.
There are many different kinds of Adjustable Rate Mortgages. Generally, interest on ARMs are determined by an outside index. Some examples of outside indexes 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.
Most ARM programs feature a cap that protects borrowers from sudden monthly payment increases. There may be a cap on how much your interest rate can increase in one period. For example: no more than a couple percent per year, even though the index the rate is based on goes up by more than two percent. Sometimes an ARM features a "payment cap" that ensures that your payment will not go above a certain amount in a given year. Plus, the great majority of ARM programs feature a "lifetime cap" — the rate can't exceed the capped percentage.
ARMs usually start at a very low rate that may increase over time. You may have heard about "3/1 ARMs" or "5/1 ARMs". In these loans, the introductory 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 adjust. Loans like this are usually best for borrowers who anticipate moving in three or five years. These types of adjustable rate loans most benefit people who plan to sell their house or refinance before the loan adjusts.
You might choose an Adjustable Rate Mortgage to take advantage of a lower introductory 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 can get stuck with increasing rates when they cannot sell or refinance at the lower property value.
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