ANALYSIS
What are the advantages of fixed rate versus adjustable rate loans?
With a fixed-rate loan, your monthly payment of principal and interest
never change for the life of your loan. Your property taxes may go up or
down, and so might your homeowner's insurance premium part of your monthly
payment, but generally with a fixed-rate loan your payment will be very
stable on both Residential loans and Commercial Loans.
Fixed-rate loans are available in all sorts of shapes and sizes: 30-year,
20-year, 15-year, even 10-year. Some fixed-rate mortgages are called
"biweekly" mortgages and shorten the life of your loan. You pay every two
weeks, a total of 26 payments a year -- which adds up to an "extra" monthly
payment every year.
During the early amortization period of a fixed-rate loan, a large
percentage of your monthly payment goes toward interest, and a much smaller
part toward principal. That gradually reverses itself as the loan ages.
You might choose a fixed-rate loan if you want to lock in an interest rate
for the duration of your loan to avoid interest rate risk. If you have an
Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can
give you more monthly payment stability on your Residential loan or
Commercial loan.
Adjustable Rate Mortgages -- ARMs, as we called them above -- come in even
more varieties. Generally, ARMs determine what you must pay based on an
outside index, perhaps the 6-month Certificate of Deposit (CD) rate, the
one-year Treasury Security rate, the Federal Home Loan Bank's 11th District
Cost of Funds Index (COFI), London Interbank Offering Rate (Libor) or
others. They may adjust every six months or once a year.
Most programs have a "cap" that protects you from your monthly payment going
up too much at once. There may be a cap on how much your interest rate can
go up in one period -- say, no more than two percent per year, even if the
underlying index goes up by more than two percent. You may have a "payment
cap," that instead of capping the interest rate directly caps the amount
your monthly payment can go up in one period. In addition, almost all ARM
programs have a "lifetime cap" -- your interest rate can never exceed that
cap amount, no matter what.
ARMs often have their lowest, most attractive rates at the beginning of the
loan, and can guarantee that rate for anywhere from a month to ten years.
You may hear people talking about or read about what are called "3/1 ARMs"
or "5/1 ARMs" or the like. That means that the introductory rate is set for
three or five years, and then adjusts according to an index every year
thereafter for the life of the loan. Loans like this are often best for
people who want the short term safety of a fixed rate which will then
convert to a variable rate after the initial fixed rate period is over.
You might choose an ARM to take advantage of a lower introductory rate and
refinance again or simply absorbing the change in rate after the
introductory fixed rate is over. With ARMs, you do risk your rate going up,
but you also take advantage when rates go down by pocketing more money each
month that would otherwise have gone toward your mortgage payment on either
your Residential Loan or Commercial Loan.
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