Differences between fixed and adjustable loans

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

Your first few years of payments on a fixed-rate loan go primarily toward interest. This proportion gradually reverses itself as the loan ages.

Borrowers might choose a fixed-rate loan in order to lock in a low rate. People select fixed-rate loans when interest rates are low and they want to lock in the low rate. If you have an Adjustable Rate Mortgage (ARM) now, refinancing with a fixed-rate loan can provide greater consistency in monthly payments. If you have an Adjustable Rate Mortgage (ARM) now, we'll be glad to help you lock in a fixed-rate at the best rate currently available. Call Metro Mortgage at 866-300-1550 for details.

Adjustable Rate Mortgages — ARMs, as we called them above — come in many varieties. Generally, the interest on ARMs are determined by a federal index. A few of these are: the 6-month CD rate, the 1 year Treasury Security rate, the Federal Home Loan Bank's 11th District Cost of Funds Index (COFI), or others.

Most programs have a "cap" that protects you from sudden monthly payment increases. Some ARMs won't adjust more than 2% per year, regardless of the underlying interest rate. Your loan may feature a "payment cap" that instead of capping the interest rate directly, caps the amount that your monthly payment can increase in a given period. Plus, almost all ARM programs feature a "lifetime cap" — this means that your rate won't exceed the cap amount.

ARMs usually start out at a very low rate that may increase over time. You may hear people talking about "3/1 ARMs" or "5/1 ARMs". In these loans, the introductory rate is set for three or five years. It then adjusts every year. These types of loans are fixed for a number of years (3 or 5), then adjust after the initial period. Loans like this are usually best for people who expect to move within three or five years. These types of ARMs are best for people who will sell their house or refinance before the loan adjusts.

You might choose an ARM to take advantage of a very low introductory interest rate and plan on moving, refinancing or simply absorbing the higher rate after the initial rate expires. ARMs can be risky when housing prices go down because homeowners could be stuck with increasing rates when they cannot sell their home or refinance with a lower property value.