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.
