1. What is a mortgage?

2. What's in a payment?

3. What is a Fixed Rate?

4. What is an Adjustable Rate?

5. Which is the better mortgage option for you: Fixed or Adjustable?

6. How much will my mortgage be?

1.  What is a mortgage?

A mortgage is basically a long-term loan that you arrange through a bank or other financial institution, or even through the seller of the property. The house and/or property serve as collateral for the loan.

A home mortgage is most likely the largest debt you will assume. You typically pay off that debt in monthly payments over a long period of time, most often 15 to 30 years.

2.  What's in a payment?

A monthly mortgage payment typically includes the following, known as PITI:

  • Principal
  • Interest
  • Real Estate Taxes
  • Property Insurance and, often, private mortgage insurance, known as PMI.

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3.  What is a Fixed Rate?

Most lenders offer several types of mortgages; the most common are the fixed-rate mortgages for 30 years or 15 years.

30-Year Fixed Rate
This mortgage is an industry standard, as total payments are spread over so many years that your monthly payments are lower than they would be on a shorter term loan. The interest rate, which is set, or locked in, at the time of obtaining the mortgage, remains the same throughout the life of the loan. On a 30-year loan, you end up paying thousands of dollars more in interest compared with a shorter-term obligation, but this interest is 100-percent tax deductible, which reduces your after-tax cost.

15-Year Fixed Rate
This mortgage also is becoming a common loan because borrowers pay a lower interest rate in exchange for larger monthly payments. Note, however, that a smaller portion of your monthly payment goes for interest and therefore the tax deduction is smaller. With a 15-year mortgage you could get an interest rate that is typically one-quarter to one-half percent lower than a 30-year mortgage. The shorter the term, generally the lower the interest. Yet, the main advantage is the fortune in interest you will be saving during the life of the loan.

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4.  What is an Adjustable Rate?

Adjustable-Rate Mortgages, known as ARMs, differ from fixed-rate mortgages in that the interest rate moves up or down. ARMs are tied to a number of indexes, which usually are published interest rates. The margin is the amount a lender adds to the index , usually two percentage points or four percentage points, to set the actual interest rate of the ARM.

The most common index for ARM adjustments is the one-year U.S. Treasury bill. The one-year bill has a yield very near that offered by the 30-year Treasury bond, which is used to set rates on 30-year fixed mortgages. The initial ARM rate is generally lower than the fixed mortgage rate, though in the current economy the one-year ARM rate has been only slightly lower, about one-quarter to one-third of a percentage point.

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5.  Which is the better mortgage option for you: Fixed or Adjustable?

Adjustable-rate mortgages (ARMs) can be very tempting to homebuyers, yet they carry a great deal of uncertainty. What if rates rise again? That's why more than 75 percent of homeowners still opt for a fixed-rate mortgage.

Here are three important questions to answer when deciding whether to choose an ARM or fixed-rate mortgage:

1. How long do you plan on staying in the home?
If you're only going to be living in the house a few years, it would make sense to take the lower-rate ARM, especially if rate adjustments are made only every three years.

2. How frequently does the ARM adjust, and when is the adjustment made?
After the initial fixed period, most most ARMs adjust every year on the anniversary of the mortgage. Some ARMs adjust every three years, based on yields on three-year Treasury securities. The new rate is actually set about 45 days before the anniversary, based on the index at that time.

3. How high could your monthly payment go if interest rates rise?
In the most cases, the fixed-rate mortgage costs less than the worst-case ARM scenario. Experts say when fixed mortgage rates are low, they tend to be a better deal than an ARM, even if you only plan to stay in the house for a few years.

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