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 (we almost
said down, too!),
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.
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
a low rate. If you
have an Adjustable
Rate Mortgage (ARM)
now, refinancing
with a fixed-rate
loan can give you
more monthly payment
stability.
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),
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 you
may read about loans
that 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
anticipate moving --
and therefore
selling the house to
be mortgaged --
within three or five
years, depending on
how long the lower
rate will be in
effect.
You might choose an
ARM to take
advantage of a lower
introductory rate
and count on either
moving, refinancing
again or simply
absorbing the higher
rate after the
introductory rate
goes up. 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.
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