by Mary Norman

Created on: August 22, 2008

One of a home buyer's greatest strengths is the knowledge of the loan programs available when financing real estate. It is critical to understand how each program's actual characteristics affect the ability to qualify, frequency of payment changes, down payment/equity requirements, and the buyer's intent regarding the length of time to remain in the residence. The various programs discussed below are not the only loan programs available in today's ever-changing marketplace. New products and remakes of old products frequently appear and disappear in a lenders line of products.

Fixed-rate Mortgage

Popularized by FHA in the 1930's, the fixed-rate mortgage changed the nature of real estate lending. In a fixed rate mortgage, the interest rate remains fixed for the life (term) of the loan. For a fixed rate mortgage, the total monthly payment amount for principal and interest should not change over the life of the loan, although ancillary costs (such as property taxes and insurance) can and do change.

Borrowers gravitate toward fixed-rate mortgages because the amount of principal and interest payment does not change during the entire term of the loan. This protects the borrower against inflation and allows secure long-term planning. A borrower can also choose to make larger monthly payments and direct the additional portion of the payment toward the principal balance of the loan. This reduces the amount of interest paid and can shorten the length of time necessary to pay off the loan.

Adjustable-rate Mortgage

The adjustable-rate mortgage (ARM) or variable-rate mortgage (VRM) has an interest rate that increases or decreases over the life of the loan based on market conditions. The changes in the interest rate are determined by an established financial index.

The most common indices are the one-year, three-year, and five-year Treasury bills; the Wall Street Prime Rate and most recently, the LIBOR-based adjustable programs. The London Interbank Offered Rate ((LIBOR) is the most common index for floating rate obligations in worldwide capital markets.

The difference between the published index rate and the rate charged on the loan is known as the margin. The margin represents the lender's cost of doing business plus profit and usually stays the same during the life of the loan.

The adjustment period is the length of time between potential interest rate adjustments. You may see an ARM described as 3/1 or 5/1. The first figure represents the initial period of the loan during which

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