30- and 15-Year Fixed Rate Mortgages
Fixed Rate Mortgages are the easiest ones to comprehend. There are basically two main loans, the 30-Year Fixed and the 15-Year Fixed. The 30-Year Fixed Rate Mortgage has a stability feature. The reason one takes this type of loan is because there is a consistent payment, one that you can be rest assured for the next 30 years will never change. So the main feature of a 30-year fixed is the stability; however, the trade off is that you are going to pay in most cases a higher rate of interest than on any other type of loan.

Presently, a 30-Year Fixed Rate mortgage is around 7.5% at no points. Now, you can get a little bit of a lower interest rate on a 15-Year Fixed Rate mortgage, but the payment will be substantially higher. This is because you are paying on an accelerated amortization schedule and paying down the loan in half the time.

The rate on a 15-Year Fixed Rate mortgage is currently around 7.00%, which is a half percent lower than the 30-Year. The 15-Year Fixed Rate mortgage is only advisable if the client can handle the payment. The one thing that you need to understand is you can never take a 15-Year and stretch it out to make it longer. You can always take a 30-Year loan and turn it into a 20- or 15-Year loan by prepaying the principal.

If cash flow gets difficult, you can always revert it to that 30-Year diluted payment, which will allow you to be more comfortable in your home loan.

Adjustable Rate Mortgages (ARMs)
An Adjustable Rate Mortgage (ARM) is a little bit more difficult to understand. Adjustable Rate Mortgages have 3 main features, the first is called Margin, the second is called Index and the third is called Caps. Those three words probably mean very little to you, so let's define them.

A Margin is the fixed or constant portion of your adjustable that never changes. It stays the same for the duration of your loan. The Index is your variance. This is the portion of your Adjustable that makes it an Adjustable. Now, if you take this fixed Margin and add it to the varying Index, you derive your interest rate. Accordingly, Margin + Index = Interest Rate. There are different types of indices. There is the 11th District Cost of Funds, the Monthly Treasury Average, The One Year Treasury Bill, the Six Month Libor, etc. Each of them has their own strengths and weaknesses.

The 11th District Cost of Funds is the slowest moving index, and the one many people like because there is very little volatility built in to it. The Monthly Treasury Bill, the One Year Treasury and the Six Month Libor are much more volatile and much more aggressive in their movement.

Once again, when you take this moving Index and add it to the Margin, you have your interest rate. The Margin becomes a critical component to the Adjustable Rate Mortgage because it is the spread above that varying Index that derives the interest rate. So, if you are my next door neighbor, Mr. Jones, and we both have an 11th District Cost of Funds Adjustable, and I have a Margin of 2 and you have a Margin of 2.5, I will always have a 0.5% better interest rate on a month-to-month basis than you do. This is because we are always adding 2 to the value of the 11th District index in my case, and always adding 2.5 to value of the 11th District index in your case.

Having a low Margin is a good thing, and you can get your Margin down to a low level by paying Points. The more Points you pay, the lower your Margin will be. If you decided not to pay any Points on your Adjustable, then your Margin will be higher. The last of the 3 items relevant in an Adjustable Rate Mortgage is the Caps, which is referred to as your liability. You might ask, how bad could these things get? What is my worst case scenario, and how ugly can my rate get? In this case, let's use the One Year Treasury bill as an example. The Caps on the One Year Treasury mortgage are at 2.0% Annual and 6% Life Cap. What that means is simply this; in any given calendar year the most you can go up or down is 2%. The most you can go up for the life of the loan is 6% from where you began.

If you started off in this One Year Treasury Bill Adjustable at an interest rate of 5% at the end of twelve months your rate would be due to have its first adjustment. You have been paying at 5% over the first twelve months of your loan and at that time the Lender will take that fixed Margin and add it to the varying Index to derive your interest rate. Now, if the Margin + Index = 6.25%, that is what your rate would be. But if Margin + Index equals 7.5%, you would be exceeding your 2% annual Cap by.5% and the rate would only go up to 7%.

There is your protection. The Cap would kick in and prevent you from going up to 7.5% because that is 2.5% higher than where you were the previous calendar year. Subsequently, the Life Cap protects you over the life of the loan, so the most your rate could ever be on this particular example would be 11%. You started at 5%, you have a 6% life cap and no matter what margin plus index ever equals, you could never exceed 11%.

Intermediate Fixed Rate Mortgages, or Short-Term Fixed Rates
There is a 3-Year Fixed, a 5-Year Fixed, a 7-Year Fixed and a 10-Year Fixed. (These are not be confused with the 15-Year Fixed Rate Mortgage that has you paying the loan off in a much more rapid manner.)

In the case of the 3-Year Fixed, these loans are amortized over 30 years, so you have a loan that is Fixed for the first 3 years, and it becomes an Adjustable Mortgage for the remaining 27 years of the 30 year cycle.

In the case of the 5-Year Fixed, it is fixed for 5 years and becomes an Adjustable for the remaining 25 years, as with the 7-Year Fixed, which is fixed for 7 and Adjustable for the remaining 23 years. Likewise, the10-Year Fixed is fixed for the first 10 years, and is an Adjustable for the remaining 20 years.

The longer that you are fixed for, of course, the more stability you are buying and therefore the higher the interest rate. You can get yourself a fairly aggressive fixed rate on a 3- or a 5-Year Fixed these days. As a matter of fact, these types of programs have been very beneficial to people who we know are not going to be in their loan for a long period of time.

Once again, let's get back to that important question, 'How long will you need to borrow the money for?' If we think rates are likely to be lower sometime in the next 3 to 5 years, or you are going to be moving in the next 3 to 5 years, these types of loans could be very effective in accomplishing the objective in the stability of a Fixed Rate but at a very low level. Who cares if the loan converts to an Adjustable, if you are not in it to see that occur.

It is not advisable to get into paying a lot of points on these types of loans. If you are going to take a loan out on a 3-Year Fixed, then you are doing that because you don't think you are going to be in it for a long period of time. The likelihood of your recuperating the cost of those points is significantly diminished as a result of short tenure in the loan.