Fixed Rate Loans

A fixed-rate mortgage provides an interest rate that will remain the same over the life of the loan. The typical term of a fixed-rate mortgage is usually 15, 20 or 30 years. The main advantage is that if interest rates increase, your interest rate will remain the same.

Adjustable-Rate mortgages (ARMs)

The adjustable rate mortgage (or "ARM") is a loan program that initially has a fixed interest rate with a predetermined period. Once the fixed rate period is up, the loan is subject to a changing interest rate. What goes up, must come down. And that's basically the principal of ARMs. The interest rate you pay is adjusted from time to time to keep it in line with changing market rates. This means when interest rates go up, your monthly home loan payments may go up. And, when interest rates go down, your monthly home loan payments may go down.

ARMs are attractive because they offer start rates that are lower than the interest rates of fixed rate home loans. This typically enables you to begin with lower monthly payments and qualify for a larger loan.

A start rate, also known as the initial interest rate, gives you a low monthly payment for a set amount of time (such as 1 year). After the start rate period is over, your interest rate is based on the performance of a financial index, such as the average interest rate or yield on Treasury bills.

How often your payments are adjusted based on the index, and how much rates and payments increase at each adjustment, depends on your loan terms. A 6-month ARM adjusts every 6 months. A 1-year ARM adjusts once a year.

At each adjustment, the new rate is computed by adding the margin — a predetermined amount that remains the same for the life of your loan — to your financial index. Example: If the interest rate for the financial index was 5.5% and your margin 2%, then your rate at the time of adjustment would be 7.5%.

Two "caps" may put a limit on the maximum amount your rate can increase. The periodic cap sets the maximum your rate can go up from one adjustment period to the next. The life cap sets the maximum interest rate for the life of the loan.
Some ARMs offer a conversion feature that allows you to convert to a fixed rate loan at certain times during your loan.

If you're worried by the thought of your payment going up in 6 months or a year, or know exactly when you'll be ready to move to a new home, you might want to look into an ARM that protects you against the possibility of rapid interest rate increases for a set number of years.

A fixed period ARM starts with a lower rate than standard fixed rate loans. Your rate then stays the same for the first 3, 5, 7, or 10 years, depending on the fixed period ARM you choose. At the end of that period, your interest rate adjusts every year like a regular ARM according to a financial index (that's why some lenders call them 3/1, 5/1, 7/1 and 10/1 ARMs)

Specialty Program and Loan Features

This is a feature that allows for a lower payment than the traditional amortized mortgages. An interest only payment does not repay any of the principal but only the interest due on the loan balance. The option to only pay interest portion usually lasts for a predetermined period, typically 5 or 10 years. Borrowers have the right to make an interest only payment or add more money to repay part of the loan balance.

Option ARMs are adjustable-rate mortgages that offer borrowers with several monthly payment options. Option ARMs usually offer an initial teaser rate as low as 1% that may last from 1 month to a year. Afterwards, the mortgage rate is then tied to a particular interest index (like the LIBOR or COFI) plus a margin. This a complex program with many guidelines that can affect its benefits. As with all loan programs, a complete understanding of the loan parameters should be made by the borrower. There are some new hybrid option ARM products that may fix the interest rate for a predetermined period thereby alleviating some of the disadvantages of an increasing interest rate environment.

Loan programs with longer terms (as opposed to 30yr terms) are becoming more popular and acceptable due to the lower monthly payments. The main disadvantage is the greater interest costs over the life of the loan.

When borrowers can not qualify for prime financing programs, sub prime programs may be available. Sub prime programs can those with low credit ratings, unique loan purpose or unique property types. Due to the higher risks of the nature of these loans, the drawbacks include higher interest rates and pre-payment penalty clauses.

Government Loans

The Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA) offer government-insured loans. These loans have features that make it easier for first-time home buyers to obtain. Features include low down payments and flexible lending guidelines.