What is a mortgage? It’s nothing more than a loan you obtain to close the gap between the cash you have for a down payment and the purchase price of the home you are buying. One more basic - the mortgage payments are comprised of PRINCIPAL, which is the repayment of the original amount borrowed, and the INTEREST, which is what the lender charges for use of the money.

There are primarily two types of mortgages: Fixed- and adjustable-rate mortgages. Before adjustable mortgages came into being, only fixed mortgages existed. They had interest rates that were FIXED, or unchanging during the life of the loan.

With a fixed mortgage, the interest rate stays the same, and your monthly mortgage payment stays the same. No surprises.

With an adjustable mortgage, also called an ARM, the interest rate VARIES, or adjusts. The interest rate typically adjusts every 6-12 months, but can adjust as frequently as every month.

You can also get an intermediate ARM, in which the initial rate may be fixed for three, five, seven or even ten years, and then the loan converts into an ARM which adjusts every 6-12 months thereafter.

So how do you choose? The best loan very much depends on your personal and financial situation.

The advantage of a fixed-rate mortgage is that you always know what your monthly payment will be. You will pay a higher interest rate to get a lender to commit to lending you money. The lender is taking a risk - if the lender agrees to loan you money at 8% over a 30-year period, but the rates go up to 15%, the lender loses money. The other downside is this: if interest rates fall significantly then you could become stranded with your mortgage if you do not qualify for a refinance at a lower rate. Even if you do qualify for a refinance, you will have to pay closing costs on the new loan. The last drawback of a fixed-rate mortgage is that some of them come with a prepayment penalty - which prevents you from refinancing or selling before a determined amount of time, usually 7 years, or you'll have to pay 6 months' of interest.

The advantage of an adjustable-rate mortgage is that an ARM starts out at a lower interest rate, and enables you to qualify to borrow more. (Just because you can qualify for more, doesn't mean you can actually afford more.) You will be subject to a fluctuating monthly payment, as your interest rate will be determined by the market level of interest rates. You will have a cap, typically 2% per year and 6% over the life of the loan. In the end, though, you may very well save yourselves thousands of dollars in lower interest charges. Another advantage is this - if you take an ARM when interest rates are very high, you won't need to refinance when rates drop. The biggest downside to an ARM is that if rates rise, your loan's interest and monthly payment will rise, too. If rates rise more than 1 or 2 percent and stay elevated, the adjustable-rate loan is likely to cost you more than a fixed-rate loan.

If you plan to stay in a home for only a short time, an ARM may be good for you. Saving money is usually guaranteed the first 2-3 years. If you plan to stay 5-7 years, a fixed-rate mortgage may be a better choice.

Only consider taking an ARM if you can answer "yes" to ALL of the following questions:

__ Is your monthly budget such that you can afford higher mortgage payments and still accomplish other financial goals, such as saving for retirement? (If you are planning to have children, you should plan for a higher household budget.)

__ Do you have an emergency reserve equal to at least 6 months of living expenses (that you can tap into to make higher mortgage payments)?

__ Can you afford the highest payment allowed on the ARM? (Your lender can tell you the cap.)

__ Are your job and income stable?

__ Can you handle the psychological stress of changing interest rates and mortgage payments?

If you answered "yes" to ALL these questions, then an ARM may be a good choice for you. The odds are with you that an ARM will save you money in the long run. Your interest rates will start lower, and likely stay lower, depending on the economy. Even if the rates do go up, they are likely to fall again. You should still come out ahead, in the long run.

ARMs work best only if you're financially and emotionally secure enough to handle the maximum possible payments over an extended period of time. ARMs work best for borrowers who consistently save 10% of their monthly income.

Don't take out an ARM just because the initially lower interest rate allows you to afford a more expensive home. Make sure you have a significant cash cushion.

If you're stuck on the fence about which mortgage is best for you, always choose the fixed-rate mortgage.

When you're ready to start your homesearch, visit www.OpenHouseCafe.info