A fixed mortgage or an ARM? And if an ARM, what kind? And what about so-called "flexible" mortgages?Unfortunately, there is no single answer to the type of mortgage that is right for you. "It depends" is as close as you will come to a definitive answer. For example, the length of time you intend to spend in your new house has a huge bearing on what type of loan you agree to. But whatever your situation, you need to understand the various types of interest rates so you won't be blindsided by those monthly payments. (For information on specific mortgage types, see Understanding Types of Mortgages and Home Loans.)Common interest rates include:
Fixed rate: The monthly payment does not change over the life of the loan in a fixed rate mortgage. For example, if you have a 30-year loan, it will be paid in full after 360 fixed monthly payments. Your payments will not fluctuate.
Adjustable rate: An Adjustable Rate Mortgage (ARM) uses an interest rate that fluctuates with an indexed rate plus a set margin; therefore the monthly payment may increase or decrease over the life of the loan.
Hybrid ARM: Hybrid ARMs have set adjustment periods, which means the interest rate changes on a predetermined schedule. For example:

• 3/1 year: Monthly payment remains fixed for 3 years and then adjusts every year thereafter
• 5/1 year: Monthly payment remains fixed for 5 years and then adjusts every year thereafter
• 7/1 year: Monthly payment remains fixed for 7 years and then adjusts every year thereafter

Flexible option ARM: The interest rate in a flexible ARM is calculated daily and changes with each monthly payment. There is a change cap limiting how much the payments can change within a year. The borrowers choose from a menu of options to pay what they want monthly.

Interest-only: For a period of time, usually 5 or 10 years, monthly payments cover only the interest on the loan. After that period, the monthly payment adjusts to include paying back the principal as well. As many borrowers can testify, the danger with this type of loan is that the property becomes devalued during the interest-only period and the owner owes more on principal than the house is worth.

Capped rate: In this type of mortgage, a lender guarantees the interest rate will never rise above a set amount for a period of time, so there is a certain amount of security for the borrower. The good news for the borrower is that if the rate decreases during that period, so do the payments.
 

You'll hear about two ways of estimating your borrowing power: pre-qualification and pre-approval. Just remember: They are not the same thing.If you are in the early stages of the home-buying process, getting pre-qualified by a lender gives you a good idea of what you can borrow. You simply provide income, debt, and down payment figures and the lender, in turn, provides you with an estimate of how much house you can afford. This is often done quickly, over the phone, and you have no obligation to use that lender to get a mortgage.

Pre-approval is the next big step. This process is much more involved, but will provide you with a specific dollar amount that you can afford. Most real estate agents will tell you that getting pre-approved is key to getting the home you want. Lenders and sellers will know you are serious about buying when it's time to make an offer. And in hot real estate markets, a buyer may need to act fast; if the competing buyer has a pre-approval in hand and you don't, they win.Pre-approval is quick and relatively painless. Usually you can get pre-approved within 24 hours with the necessary income verification and supporting paperwork on hand; online sites can pre-approve you immediately, but you'll have to provide the verification to a lender eventually. And, as with pre-qualification, you are under no obligation to use that lender for the loan (though most buyers will).

• Pay stubs and W2s (lenders are looking for income verification for two years)
• Two or three months of bank statements
• If you are self-employed, you will need tax returns from the last two years
• Divorce decree (if applicable)
• Loan documents on your current home (if applicable)
• Many lenders and brokers will ask you to pay for the credit report required for pre-approval, but this is generally the only fee you will encounter during pre-approval (sometimes, though, a lender will charge a fee; be sure to ask if it's free)

The amount you borrow to actually buy your house is one thing; the fees required to close the transaction are quite another, and they amount to from 3 to 5 percent of your overall mortgage.At the real estate closing, you will be given a stack of paperwork that shows the loan fees line-by-line. (You should already have seen these in your Good Faith Estimate, but they might vary.) The fees below are what is generally required, but every buyer will not pay every fee listed. For example, maybe you worked a deal with the seller to pick up part of the closing costs. And there are many geographic differences. Finally, all lenders do not charge every fee shown.

Commissions: Payment for the work real estate agents have done. Traditionally it is 6% split between buyer and seller agents; usually 3% to buyer's agent, 3% to seller's agent. The seller usually pays these. Note: These costs are not included in your lender's Good Faith Estimate.

Application fee: An application fee is a fee to reimburse the lender for internal costs associated with initiating the application process, usually under $300.

Appraisal fee: The lender hires an independent appraiser to determine whether the property is worth the sales price you've offered for it. Expect $200-$500. It can be higher or lower, depending on the size of the property and appraisal fees in your area.

Assumption fee: Buyers sometimes take over (assume) the seller's existing mortgage. If so, the lender may charge a variable fee.

Credit report fee: Covers obtaining a credit report to determine whether you are an acceptable credit risk. Also called a "credit check fee," it averages about $25 per credit report checked. although some borrowers have paid three times more.

Interest: Most lenders require the buyer to pay the interest that will accrue on their loan from the date of settlement to the first monthly mortgage payment due date.

Mortgage insurance application fee: When the down payment is less than 20 percent of the purchase price, you are required to carry Private Mortgage Insurance, PMI, to protect the lender should you default on your loan. The lender charges a variable fee to process the application.

Lender's inspection fee: If you are building a new home or buying a home that's under construction, the lender may charge an inspection fee, usually under $100. This pays for an inspection by the lender or outside inspector of your house or property.

Lender's attorney fee: About $400. If a lender involves an attorney in a transaction for any reason, the buyer pays.

Loan origination fee: Fee for establishing a new loan. It is paid to the lender for his or her services in originating the loan. The fee usually varies from 0.5% (half a point) to 2% (two points) of the loan amount.

Loan discount points: Refers to a one-time charge imposed by the lender or mortgage broker to lower the interest rate and therefore the monthly mortgage payment. The more points paid up front, the lower the interest rate. The loan discount is also called "point" or "discount point." Note that the interest rate does not drop by one percent per point.

Mortgage broker fee: Paid to a mortgage broker, typically in a commission based upon the amount borrowed, in return for finding the mortgage.

Mortgage insurance premium: Some lenders require borrowers to pay their first year's mortgage insurance premium up front. Other lenders ask for a lump sum insurance premium payment at closing that covers the life of the loan.

Process fee: Charged by the lender to cover costs associated with the processing and closing of a mortgage loan.

Reserve account funds: Your monthly mortgage payments are likely to include a pro-rated amount to cover payments for property taxes and homeowners insurance. This money is held in a "reserve" or "escrow" account by the lender who makes the payments for you. At closing, your lender may require you to pony up advance payments just to be sure the reserve fund has enough money to pay the bills.

Tax-related service fee: Paid to set up a service which identifies the payment due date of local taxes for the servicer of the loan.

Underwriting fee: Covers the final analysis and approval of the mortgage; often the lender's cost to the investor that will subsequently purchase the loan.

Wire transfer fee: Covers the cost of wiring the money around, which is usually done by escrow.

Annual assessments: If you will have annual assessments made by your condominium or homeowners association, you will have to pay two months' worth up front.

Flood insurance premium: Lenders may require flood insurance, with the premium paid at closing, depending on the property location.

Homeowners insurance premium: A homeowners insurance policy protects the lender (as well as the owner) against loss of the house from fire, wind, or other natural disasters. Usually the buyer pays some of the premium payment at closing.

Taxes: Buyers pay two months' worth of city property taxes and two months of county property taxes at closing.

Attorney fees: Varies, but could be $500 to $1000 or more. In some parts of the country an attorney, not a title company, handles closing, and sometimes an attorney is hired by the lender to review certain documents.

Notary fees: Pays for the notary public who witnesses that the signatures on closing documents are made by the people named in them.

Title insurance fees: Average is $350, but could be as high as one percent of the loan. Title insurance is a policy that protects the owner and/or lender by guaranteeing the title to the property is clear.

Title search: About $200. A search is done to make sure there aren't any unpaid mortgages or tax liens on the property.

Courier fee: Charged if a courier picks up and delivers documents.

Lead-based paint inspection: Covers the cost of evaluating lead-based paint risk.

Pest inspection: Depending on location, a termite or other pest inspection may be required.

Radon test: Covers the cost of testing for the presence of radon gas, which can be a problem in some parts of the country.

Recording fees: Average about $100. This covers getting the sale recorded in the public record.

Survey: About $1000 for a survey of the property boundaries.

Transfer taxes: This is a fee, usually collected by the state, for transferring the title of the property within a certain jurisdiction. The fee varies.
 

Q. I am scared of those ARMs and their fluctuating rates. I know that they are cheaper than a fixed mortgage, but ... Should I be more brave and go for an ARM?A. Not necessarily. If security is important to you, then shop for the best fixed-rate mortgage out there. Pay attention to the interest rates and how they are fluctuating, and be sure to get your lender to lock-in, or guarantee the interest rate if the loan is closed within a specific time.

Q. Eek! My lender says I have to pay Private Mortgage Insurance on my mortgage. How much is it going to be anyway?A. Does your lender wear a helmet when he skis? It's the same thing, he wants to protect himself in case you default on your loan. You can expect to pay 1-5 percent of the total mortgage with the initial premium, and possibly a monthly fee on top of that. Be sure to ask that cautious lender why he is requiring PMI.

Q. I'm a coward and I know it. My lender showed me an amortization schedule that scared me to death. Almost everything I pay at the beginning of my loan goes to the bank. What's up?A. Looking at an amortization schedule can make the best of us squirm, but there's no way to avoid the truth: Your loan payments are spread evenly over a period of time (amortized), and the interest takes up a bigger chunk of the payment at the beginning. Things look up toward the end of the life of the loan: Your payments go mainly toward the principal then.
 

Amortization is a true measure of what a borrower pays annually against a loan. A loan has a life — whether it's 15, 30, or even 50 years. You pay in installments, and the principal decreases (except in the case of interest-only loans, negative amortization and reverse mortgages) until the loan is paid off by the end of the term. The payments are evenly spread over the life of the loan, with the interest payments making up the majority of the payment at the beginning, and then principal paid off toward the end of the term. Pay attention to the amortization schedule, which shows the payments for the life of the loan including interest.
 

Think it's a good thing to pay off a loan? Well, it might be, but you could pay a penalty if you do. Penalties apply for a specific period of time, usually 1, 2, or 3 years after the loan is originated. How much is the penalty? It varies, but it could be six months of interest or 2 percent of the principal remaining on the loan — nothing to sneeze at.Some lenders offer very low (and therefore tempting) interest rates in exchange for the borrower's agreeing to pay a penalty for early payoff. The existence of prepayment penalties is supposed to be disclosed by the lender, but it is worth asking outright if penalties apply to your loan.Prepayment penalties are more common with non-traditional loans than conforming loans, and often they are aimed at borrowers with bad credit who will agree to them if it's the only way they can get the loan.

If you get a portion of your down payment from good ol' mom and dad, you need to leave it in the bank for more than two months or obtain a gift letter explaining that the money is a gift, not a loan.

Ask your lender for a Good Faith Estimate (GFE), which includes all costs and fees you will incur. But be aware that it is just that — an estimate. Third-party fees can change and are not under your lender's control. Still, a good lender should be up-to-date on what the fees will be. When you ask for references from friends, ask how close the GFE was to reality.

There's no free lunch (or free loan): You can choose between higher rates with lower points, or lower rates with higher points. The key is to compare different types of loans to see what works for your needs.

In general, you should never pay more than 1 to 1-1/2 points to a lender, depending on the loan. (In certain circumstances, you might pay 2 percent, but only if there is a good reason; e.g., bad credit, complex loan, or you are getting a great interest rate.)

Lenders and your local bank will have the latest rates for each type of loan. And you can request them on Zillow Mortgage Marketplace. Shop around for rates in your city to see who is offering the best deal locally. But be sure you are comparing the exact same loan; look at the points as well as the interest rate. (Zillow Mortgage Marketplace's quote form is designed to make it easier for lenders to compare apples-to-apples when looking at quotes.)

Compare loans using the Annual Percentage Rate (APR) which wraps up the interest, points and fees in an effective annual rate over the life of the loan. When you are using the APR to compare loans, make sure you are comparing apples to apples. You need the same loan from different lenders to make the comparison work. Compare the APR on two identical loans and choose the one with the lesser rate.

Pay half your house payment every two weeks instead of one monthly payment. This results in 26 payments per year, one more payment annually than if you just paid monthly. The re-amortized loan will eventually result in more of the payment paid on principal and less on interest. The extra payments go to pay down the principal on the loan. (Make sure there is no bank cost for making these extra payments.)

You have the right under federal law to get an itemized list of fees at least one day prior to closing. This is provided on the HUD-1 Settlement Form. All fees that you must pay are itemized separately. Go over the list ahead of time, and read the sales contract one more time as well. Make a list of closing costs you agreed to pay and check it against the HUD form.

Pay attention to the Yield Spread Premium — a percentage of the loan amount that a lender pays a broker for a loan with a higher interest rate, and lower fees. The YSP must be disclosed on the HUD-1 Settlement form. If your loan includes YSP, your mortgage rate could end up higher than the best mortgage you could qualify for without it.

Your lender will lock in, or commit to, your rate when you apply if you ask him. If he does not, you might end up with a higher rate than quoted. (Of course, if you think rates will decrease between the time you apply and when you actually obtain the loan, you could chance it without a lock.) If you ask for a lock-in, ask if there is a fee involved. And be sure to get the agreement in writing. The written commitment should also reveal the points to be paid at closing.

© Zillow, Inc. 2009. Originally posted