Fixed Rate Mortgages:
With a fixed rate mortgage the interest rate and payments remain the same throughout the term of the loan. This offers you
the advantage of knowing that the amount you owe each month will never change. However, the lender sets the interest rate on a fixed higher than that on an adjustable rate mortgage as protection against losing money.
This increases monthly payments and may make it harder for you to qualify for a mortgage.
Adjustable Rate Mortgages (ARM's):
With this type of mortgage, the loan period is fixed but the interest rate varies as
inflation and financial markets fluctuate. The adjustments in the interest rate on the loan are set at regular intervals, typically six months or one year. Often, these loans have a cap on how much the interest rate can
be adjusted at each interval and how much it can vary over the term of the loan.
An Adjustable Rate Mortgage may also have a payment cap. This guarantees that the monthly payment will not change by more than a preset
amount. If the interest rate rises to a point where the total interest per month is greater than the maximum payment permitted by the cap, the payment won't rise, but you still owe all the interest. The interest you do
not pay is added to the principal of the loan, increasing the total amount you owe. This is called negative amortization.
Graduated Payment Mortgage:
A variation on the fixed rate mortgage, this type of loan has a
fixed interest rate and loan period. The payments, however, start low and increase over the first 5 to 10 years of the loan before becoming constant.
If you expect your income to rise significantly in the first few
years after your home purchase, you should investigate the graduated payment option. Be warned: you may accumulate negative amortization if your low initial payments do not cover the interest on the mortgage. The total
amount you owe may actually increase during the first couple of years!
These combine the characteristics of fixed rate and adjustable rate mortgages. Some offer 3, 5, or 7-year fixed terms before
reverting to an adjustable rate mortgage.
Lenders offer a lower interest rate on a loan with a shorter period because they are less likely to loose money due to dramatic market fluctuations. The
traditional loan is a 30-year fixed. But in recent years, 15 year loans have become also popular.