Fixed Rate. The interest rate is fixed. Your monthly payments, i.e., total including interest and principal, will stay the same for the life of the loan. Your property taxes and homeowners insurance may increase, but your monthly payments will be very predictable overall. Fixed rate mortgages are available for 30 years, 20 years, 15 years and even 10 years.

Adjustable Rate Mortgages (ARMS). Your monthly payments will be lower to start off with because these loans generally begin with an interest rate that is 2-3 percent below a comparable fixed rate mortgage. You could use the lower rate to buy a more expensive home, or use the savings for other needs. What's the catch? The interest rate changes at specified intervals (for example, every year) depending on changing market conditions and the particular "index" your rate is tied to. If interest rates go up, so does your monthly mortgage payment. However, if rates go down, your mortgage payment will go down, too. Some mortgages actually combine aspects of fixed and variable rate mortgages - starting at a low fixed rate for seven to ten years, for example, then adjusting to market conditions.

Balloon Mortgages. These mortgages offer low, fixed rate payments as though the mortgage was a thirty-year term. But instead, the loan has a fairly short term - for example, five to seven years - and then ends with a single large payment (the "balloon") for all the remaining principal.

The Fixed vs. ARM Decision
ARM loans are more popular whenever interest rates are high. 1998 was a good year for fixed rate loans as consumers locked in the record low interest rates. Rates soared upward, however, toward the middle of 1999 making ARM loans more attractive. But first-time homebuyers must look beyond interest rates and ask themselves a few key questions before deciding whether to choose an ARM or a fixed interest rate loan.

Here Today, Gone Tomorrow. The most important question is: "How long do I plan to own this home?" Is it a "starter home" or do you plan to live there into the foreseeable future? If you plan to move in a few years, an ARM or Balloon Mortgage could save you money for the short time you'll be paying the loan. By the time the rate has a chance to go up, you'll hopefully be gone.

Prepare to Roll the Dice. The next question to ask is: "Is my income likely to rise enough to cover higher mortgage payments if interest rates go up?" Or more to the point, are you willing to gamble that interest rates won't go up in return for making smaller payments in the short term? Or that they'll go down during the period you own the home, saving you money? If you're not the adventurous type, perhaps a fixed-rate loan is for you, especially if rates are currently reasonable.

Where's the Equity in Your Decision? Ask yourself your philosophy toward spending and investment. Would you rather reduce your debt and build your home's equity faster, by paying off the principal faster? Perhaps a 15 to 20-year fixed rate loan is the right choice. Or would you rather put less toward your home loan and more toward other things, such as investments with a possibly higher rate of return? Consider an ARM.

Your Debt Position. Finally ask yourself: "Will I be taking on other sizable debts, such as a loan for a car or school tuition, in the near future?" Answer this before deciding how much home you can afford, period. A home should enhance your quality of life into the future, without making unreasonable sacrifices. Piling on too much home debt, or forgoing some of it now with an ARM, will affect your ability to afford future expenses for other necessary things.