What is the difference between a Fixed Rate Mortgage and an Adjustable Rate Mortgage?

There are many different types of home financing loan programs, but for most Americans that just want to make their monthly payments and own their home one day, the 30 Year Fixed Rate Home Mortgage is the best option.

This is the best option because it gives them the lowest possible payment every month, and the payment will not change over the life of the loan.  The Amortization is the same as the loan, 30 years, or "Fully Amortized."  These are widely available loans and they typically have the broadest underwriting guidelines available to most borrowers.

The next few types of loans are typically only used in special circumstances.

Interest Only ARM loans (Adjustable Rate Mortgage):  In rapidly appreciating areas, these are a great option to "get your foot in the door", have a manageable payment every month, and then the goal is to refinance into a 15 or 30 year fixed loan, once you have been able to get rid of the M.I. (Mortgage Insurance.)  This has been typically at 80% LTV (Loan To Value) however, recent changes to the M.I. schedules may require you to refinance to take advantage of removing the M.I.  Please make sure you discuss with your loan officer about removing the M.I.  These loans also have "caps" associated with the adjustable terms.  The caps are typically 2%/2%/6%.  (That is, 2% initial maximum jump from the original rate, 2% maximum jump every adjustment term, with a maximum of 6% increase cap over the initial rate for the life of the loan.)

Fully Amortized ARM loans:  Very similar usage to the Interest Only ARM Loans above.  The difference is that Interest AND Principal are due each month.

Neg-Am Loans:  (Negative Amortization Loans, Sometimes these are also called PayOption ARM loans):  The lender actually gives you 4 options to pay each month, but what was not crystal clear to the average borrower was that if you chose the cheapest payment every month, true, it would not hurt your credit score, however, you would not even be covering all of the interest due each month, so they would "tack on" the interest to your principal balance at the end of the loan term.  OUCH!  This loan has traditionally been reserved for ONLY the most savvy investor who understands about cash flow.  Mostly commercial real estate developers, who plan on selling in the near future, and are just streamlining their cash flow for the short term.  This may be the "straw that broke the camel's back" with the mortgage meltdown in 2007 - 2008. 

Subprime Loans:  These are typically higher interest rate loans, and either 2/28 or 3/27.  And most of them have a PrePayment Penalty built into them (unless not allowed by state law.)  These were meant to be a "band aid" loan, typically to get a borrower into their home, or refinance their home with this loan, then work on repairing their credit, then refinance into something more traditional.  This is the loan program that got all the blame for the mortgage meltdown of 2007-2008.  And while there was definitely some abuse of these types of loans, the FINAL straw was the Pay-Option ARMs.