Differences Between Adjustable and Fixed Rate Loans

A fixed-rate loan features the same payment for the entire duration of your loan. The property taxes and homeowners insurance will increase over time, but for the most part, payments on these types of loans vary little.

Your first few years of payments on a fixed-rate loan are applied primarily toward interest. The amount paid toward principal goes up gradually each month.

You might choose a fixed-rate loan to lock in a low interest rate. Borrowers choose fixed-rate loans because interest rates are low and they want to lock in at this low rate. For homeowners who have an ARM now, refinancing into a fixed-rate loan can provide greater monthly payment stability. If you currently have an Adjustable Rate Mortgage (ARM), we’d love to assist you in locking a fixed-rate at a favorable rate. 

Adjustable Rate Mortgages — ARMs, as we called them above — come in many varieties. Generally, interest on ARMs are based on 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 ARMs are capped, so they can’t go up over a specific amount in a given period of time. Your ARM may feature a cap on how much your interest rate can go up in one period. 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 directly, caps the amount that the payment can increase in one period. In addition, the great majority of ARMs feature a “lifetime cap” — this cap means that the rate won’t go over the capped percentage.

ARMs usually start out at a very low rate that usually increases as the loan ages. You may hear people talking about “3/1 ARMs” or “5/1 ARMs”. In these loans, the introductory rate is set for three or five years. It then adjusts every year. These types of loans are fixed for 3 or 5 years, then they adjust after the initial period. These loans are often best for borrowers who expect to move within three or five years. These types of adjustable rate programs are best for people who will sell their house or refinance before the initial lock expires.

You might choose an Adjustable Rate Mortgage to take advantage of a very low introductory interest rate and count on moving, refinancing or absorbing the higher rate after the introductory rate expires.

Have questions about mortgage loans? Call us at (303) 779-0591. It’s our job to answer these questions and many others, so we’re happy to help!