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Fixed Rate vs Adjustable Rate
What are the advantages of fixed rate versus adjustable rate loans?
With a fixed-rate loan, your monthly payment of principal and interest never changes for the life of your loan. Your property taxes may go up and so might the homeowner's insurance premium part of your monthly payment, but the principal and interest payment remains fixed. Fixed-rate loans are available in all sorts of shapes and sizes: 50-year, 40-year, 30-year, 25-year, 20-year, 15-year, 10-year, even 5-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. Adjustable Rate Mortgages -- ARMs -- 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), or others. They may adjust every month, six months or once a year. At each adjustment, a margin (which is fixed for the life of the loan) is added to the current value of the index to determine your new interest rate and payment. 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 guarantee that rate for anywhere from a month to ten years. A Negative Amortization Mortgage- or Option ARM is a loan that gives you three payment options every month. You can also think about it as having a built in equity line. The monthly payment options are:
Every month, you can pick the payment that works best for you |
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