Mortgage Interest Rates Explained

The world of mortgages is confusing at best. There are literally thousands of mortgage companies anxious to loan you money and hundreds of terms to learn. Where do you begin, and how on earth can you compare mortgages to find out what is best for you? To begin, it is most helpful to learn the basic types of interest rates, how they work and what it means to you. Here are the most common types of interest rates explained:

Fixed rates. Fixed rates are the old standby. They are what you'll find when you're investigating traditional mortgages. When your loan has a fixed rate, your interest doesn't change throughout the entire life of your loan. Most fixed rate mortgages last for 10, 15, 20 or 30 years. This is a great option when interest rates are low. If you can lock in an interest rate of 4%-8% for the life of a 30 year loan, you're doing pretty well. However if interest rates are high, you may want to look for the next type of interest rate option.

Adjustable Rate Mortgage. Otherwise known as an ARM, an adjustable rate mortgage is just that - adjustable. Usually, lenders guarantee a rate for a specific period of time, generally three, five, or seven years. However, once that time period has expired, the interest rate on the loan will change to the current going rate. Generally, there is a cap on how high the interest rate can go. This is called a ceiling, and your ceiling will be documented in your lending agreement.

For example, if the current fixed interest rate is 10% and you decide you'd rather go with an ARM, which is generally lower than the current fixed rate, then maybe you could get an ARM at 7% guaranteed for five years. Once your five years have expired, the current interest rate could be lower than your current interest rate or it could be higher. If it is up to 14% that's a huge jump and your mortgage will go up quite a bit; however, if you have a 3 point ceiling agreement in your mortgage your interest rate will only go up to 10%. With an ARM, your interest rate is subject to change every year after the initial reduced rate period has expired.

Two Step mortgage. A two step mortgage works very similarly to an ARM. You will lock in an interest rate, usually a bit lower than the going interest rate, for a designated period of time. Once that time has expired, your second step is for your interest rate to jump to the going rate. It's a bit of a gamble because you don't know what the future holds. However, it does enable you to get into your home at a lower interest rate.

Balloon. With a balloon mortgage your interest rate and monthly payment remain the same for a certain number of years. At the end of that time period, your loan is due in full. If you choose this option you will have to refinance, pay off your home, or sell your home. Balloons generally run for five or seven years.

There you have it. Just about any mortgage you come across will fall into one of these discussed categories. Happy borrowing!