Fixed versus adjustable rate loans

A fixed-rate loan features a fixed payment over the life of the mortgage. The property taxes and homeowners insurance will go up over time, but for the most part, payments on fixed rate loans vary little.

Early in a fixed-rate loan, a large percentage of your monthly payment goes toward interest, and a much smaller percentage goes to principal. The amount paid toward principal goes up slowly each month.

You might choose a fixed-rate loan to lock in a low rate. Borrowers select these types of loans when interest rates are low and they wish to lock in at the lower rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can offer more consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'll be glad to assist you in locking a fixed-rate at a favorable rate. Call The Mortgage Partner at (949) 249-3067 for details.

Adjustable Rate Mortgages — ARMs, as we called them above — come in even more varieties. ARMs usually adjust every six months, based on various indexes.

Most ARMs are capped, which means they can't increase over a specific amount in a given period. Your ARM may feature a cap on how much your interest rate can increase in one period. For example: no more than two percent per year, even if the underlying index increases by more than two percent. Sometimes an ARM has a "payment cap" which guarantees that your payment won't go above a certain amount over the course of a given year. Most ARMs also cap your interest rate over the life of the loan period.

ARMs usually start 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". For these loans, the initial 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 they adjust. Loans like this are usually best for borrowers who expect to move within three or five years. These types of adjustable rate loans benefit people who plan to sell their house or refinance before the initial lock expires.

You might choose an ARM to get a very low introductory interest rate and count 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 their home or refinance at the lower property value.