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 Three Types of Mortgages 

 Fixed Rate Mortgage 

A fixed rate mortgage carries an interest rate that will be set at or before the time of the loan, and remain constant for the length of the mortgage. Typically fixed rate mortgages range between 15-year and 30-years. If you have a 30-year mortgage, the rate you pay will be fixed for 30 years. At the end of the 30th year, if payments have been made on time, the loan is fully paid off. To a borrower the big advantage is that the rate will remain constant and the monthly payment s/he must make will remain the same (although property taxes may increase affecting your monthly payment). Thus it reduces the risk that the borrower may be called upon to make higher interest payments than they counted on.

If the rates fall, the homeowner can potentially pay off the loan, usually by "refinancing" the house at the then lower interest rates. As a result, lenders usually demand a higher interest rate on a fixed rate loan -- which means higher monthly payments -- than the initial rate and payments on adjustable or balloon mortgages.

 Adjustable Rate Mortgage 

An adjustable rate mortgage (often called an "ARM") offers a fixed initial interest rate and a fixed initial monthly payment. However, both are "fixed" not for the life of the loan, but for a much shorter period of time, often 6 months to 5 years. With an ARM, after the initial fixed period, both the interest rate and the monthly payments adjust on a regular basis to reflect the then current market interest rates based on an index. (Each lender can use its own index and formula, and some may be more or less advantageous to borrowers.) Each lender may also use different adjustment periods. For example, some ARMs may be subject to adjustment every 3 or 6 months while others may be adjusted just once a year. In addition, some ARMs limit the amount that the rates can increase (or decrease) on any adjustment, perhaps to no more than ½ of one percent on any adjustment date. An ARM usually carries a lower initial interest rate and lower initial monthly payment for the buyer in exchange for the buyer taking the risk that rates may rise in the future, which would mean both the rate and monthly payments will adjust upwards.

 Balloon Mortgage 

A balloon mortgage has a fixed interest rate and fixed monthly payment, but after a fixed period of time, such as 5 years, the entire balance of the loan becomes due at once. As a practical matter, the homeowner is unlikely to have enough cash to pay off the entire loan balance after 5 years, so she/he will then have to obtain a new mortgage. If she/he can't get another mortgage, she/he may lose the house. Balloon mortgages are usually a last resort for those who can't qualify for a standard fixed or adjustable rate mortgage.