Differences between adjustable and fixed rate loans

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A fixed-rate loan features the same principal and interest payment for the entire duration of the loan. Your property taxes may go up (or rarely, down), and your insurance rates might vary as well. But generally payments for your fixed-rate loan will be very stable.

Your first few years of payments on a fixed-rate loan are applied mostly toward interest. The amount applied to your principal amount increases up gradually each month.

You can choose a fixed-rate loan in order to lock in a low interest rate. Borrowers choose fixed-rate loans because interest rates are low and they want to lock in at the low rate. For homeowners who have an ARM now, refinancing with a fixed-rate loan can provide more monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we'll be glad to help you lock in a fixed-rate at the best rate currently available. Call Ann Jones at (512) 422-9036 to discuss how we can help.

Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. Generally, the interest for 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.

The majority of Adjustable Rate Mortgages feature periodic caps, which means rates won't go up over a certain amount in a given period. Some ARMs can't adjust more than two percent per year, regardless of the underlying interest rate. Sometimes an ARM has a "payment cap" which ensures 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.

ARMs usually start out at a very low rate that usually increases over time. You've probably read about 5/1 or 3/1 ARMs. For these loans, the introductory rate is set for three or five years. After this period it adjusts every year. These loans are fixed for 3 or 5 years, then adjust. Loans like this are usually best for borrowers who anticipate moving within three or five years. These types of ARMs benefit people who will sell their house or refinance before the initial lock expires.

Most people who choose ARMs do so because they want to get lower introductory rates and do not plan on remaining in the home for any longer than this introductory low-rate period. ARMs are risky when property values decrease and borrowers cannot sell their home or refinance their loan.

Have questions about mortgage loans? Call us at (512) 422-9036. We answer questions about different types of loans every day.

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