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This payment amount is independent of the additional costs on a home sometimes handled in escrow, such as property taxes and property insurance. Consequently, payments made by the borrower may change over time with the changing escrow amount, but the payments handling the principal and interest on the loan will remain the same.

Fixed rate mortgages are characterized by their interest rate, amount of loan, and term of the mortgage. With these three values, the calculation of the monthly payment can then be done.

Margin - For FRMs where the index is applied to the interest rate of the note on an "index plus margin" basis, the margin is the difference between the note rate and the index on which the note rate is based expressed in percentage terms. This is not to be confused with profit margin. The lower the margin the better the interest rate of the loan is. Margins will vary between 2%-7%.

Index - A published financial index such as LIBOR used to periodically adjust the interest rate of the ARM.

Term - The length of time of the loan. The number of payments is independent of this term, so a 30-year term would have 30 payments for a yearly payment plan, but 360 payments for a common monthly plan.

Home Equity Lines of Credit HELOC - Since HELOCs are intended by banks to primarily sit in second lien position, they normally are only capped by the maximum interest rate allowed by law in the state wherein they are issued. For example, Florida currently has an 18% cap on interest rate charges. These loans are risky in the sense that to lenders, they are practically a credit card issued to the borrower, with minimal security in the event of default. They are risky to the borrower in the sense that they are mostly indexed to the Wall Street Journal Prime Rate, which is considered a Spot Index, or a financial indicator that is subject to immediate change (as are the loans based upon the Prime Rate). The risk to borrower being that a financial situation causing the Federal Reserve to raise rates dramatically (see 1980, 2006) would effect an immediate rise in obligation to the borrower, up to the capped rate.

The fact that a fixed rate mortgage has a higher starting interest rate does not indicate that this is a worse form of borrowing compared to the adjustable rate mortgages. If interest rates rise, the ARM cost will be higher while the FRM will remain the same. In effect, the lender has agreed to take the interest rate risk on a fixed rate loan. Some studies have shown that the majority of borrowers with adjustable rate mortgages save money in the long term, but that some borrowers pay more. The price of potentially saving money, in other words, is balanced by the risk of potentially higher costs. In each case, a choice would need to be made based upon the loan term, the current interest rate, and the likelihood that the rate will increase or decrease during the life of the loan.

Adjustable rate mortgages are characterized by their index and limitations on charges (caps). In many countries, adjustable rate mortgages are the norm, and in such places, may simply be referred to as mortgages.

The popularity of hybrid ARMs has significantly increased in recent years. In 1998, the percentage of hybrids relative to 30-year fixed rate mortgages was less than 2%; within 6 years, this increased to 27.5%.

Like other adjustable-rate products, hybrid ARMs transfer some interest rate risk from the lender to the borrower, thus allowing the lender to offer a lower note rate.

Option ARMs - An "option ARM" is a loan where the borrower has the option of making either a specified minimum payment, an interest-only payment, or a 15-year or 30-year fixed rate payment in a given month. The minimum payment is less than an interest-only payment and therefore results in negative amortization, while the full payment is the fully amortized share of interest and principal.

Option ARMs are popular because they are usually offered with a very low initial interest rate (a so-called "teaser rate") and a low minimum payment, which permits borrowers to qualify for a much larger loan than would otherwise be possible.

Option ARMs are best suited to people in fields with sporadic income, such as some self-employed people or those in a highly seasonal business. For example, someone who makes the majority of their income around the winter holiday season, but who earns minimal income during the following few months may wish to pay the full payment during their busy season, but drop back to the interest-only payment or the minimum during a period of reduced earnings. This gives greater flexibility to how the mortgage is paid. With a fixed-payment loan, if the borrower was unable to meet the fixed payment, they would risk late fees or foreclosure.

The main risk of an Option ARM is "payment shock", when the negative amortization reaches a stated maximum, at which point the minimum payment will be raised to a level that amortizes the loan balance.[4] Another risk, as with any loan with potential negative amortization, is that the increased loan balance will reduce or eliminate the borrower's equity in the financed property, or if the value of the property declines, make it impossible to sell the property for an amount that will repay the loan.

Margin - For ARMs where the index is applied to the interest rate of the note on an "index plus margin" basis, the margin is the difference between the note rate and the index on which the note rate is based expressed in percentage terms. This is not to be confused with profit margin. The lower the margin the better the loan is as the maximum rate will increase less at each adjustment. Margins will vary between 2%-7%.

Index - A published financial index such as LIBOR used to periodically adjust the iterest rate of the ARM.

Start Rate - The introductory rate provided to purchasers of ARM loans for the initial fixed interest period.

Period - The length of time between interest rate adjustments. In times of falling interest rates, a shorter period benefits the borrower. On the other hand, in times of rising interest rates, a longer period benefits the borrower.

Floor - A clause that sets the minimum rate for the interest rate of an ARM loan. Most loans come with a Start Rate = Floor feature, but this is primarily for Non-Conforming (aka Sub-Prime or Program Lending) loan products. This prevents an ARM loan from ever adjusting lower than the Start Rate. An "A Paper" loan typically has either no Floor or 2% below start.

Payment Shock - Industry term to describe the severe (unexpected or planned for by borrower) upward movement of mortgage loan interest rates and its effect on borrowers. This is the major risk of an ARM, as this can lead to severe financial hardship for the borrower.

Cap - Any clause that sets a limitation on the amount or frequency of rate changes.

Loan caps provide payment protection against payment shock, and allow a measure of interest rate certainty to those who gamble with initial fixed rates on ARM loans. There are three types of Caps on a typical First Lien Adjustable Rate Mortgage or First Lien Hybrid Adjustable Rate Mortgage.

Initial Adjustment Rate Cap - The majority of loans have a higher cap for initial adjustments that's indexed to the initial fixed period. In other words, the longer the initial fixed term, the more the bank would like to potentially adjust your loan. Typically, this cap is 2-3% above the Start Rate on a loan with an initial fixed rate term of 3 years or lower and 5-6% above the Start Rate on a loan with an initial fixed rate term of 5 years or greater.

Rate Adjustment Cap - This is the maximum amount by which an Adjustable Rate Mortgage may increase on each successive adjustment. Similar to the initial cap, this cap is usually 1% above the Start Rate for loans with an initial fixed term of 3 years or greater and usually 2% above the Start Rate for loans that have an initial fixed term of 5 years or greater

Lifetime Cap - Most First Mortgage loans have a 5% or 6% Life Cap above the Start Rate (this ultimately varies by the lender and credit grade).

Industry Shorthand for ARM Caps

Inside the business caps are expressed most often by simply the 3 numbers involved that signify each cap. For example, a 5/1 Hybrid ARM may have a cap structure of 5/2/5 (5% initial cap, 2% adjustment cap and 5% lifetime cap) and insiders would call this a 5-2-5 cap. Alternately a 1 year arm might have a 1/1/6 cap (1% initial cap, 1% adjustment cap and 6% lifetime cap) known as a 1-1-6, or alternately expressed as a 1/6 cap (leaving out one digit signifies that the initial and adjustment caps are identical).

Negative amortization ARM caps

See the complete article for the type of ARM that Negative amortization loans are by nature. Higher risk products, such as First Lien Monthly Adjustable loans with Negative amortization and Home Equity Lines of Credit aka HELOC have different ways of structuring the Cap than a typical First Lien Mortgage. The typical First Lien Monthly Adjustable loans with Negative amortization loan has a life cap for the underlying rate (aka "Fully Indexed Rate") between 9.95% and 12% (maximum assessed interest rate). Some of these loans can have much higher rate ceilings. The fully indexed rate is always listed on the statement, but borrowers are shielded from the full effect of rate increases by the minimum payment, until the loan is recast, which is when principal and interest payments are due that will fully amortize the loan at the fully indexed rate.

Home Equity Lines of Credit HELOC

Since HELOCs are intended by banks to primarily sit in second lien position, they normally are only capped by the maximum interest rate allowed by law in the state wherein they are issued. For example, Florida currently has an 18% cap on interest rate charges. These loans are risky in the sense that to lenders, they are practically a credit card issued to the borrower, with minimal security in the event of default. They are risky to the borrower in the sense that they are mostly indexed to the Wall Street Journal Prime Rate, which is considered a Spot Index, or a financial indicator that is subject to immediate change (as are the loans based upon the Prime Rate). The risk to borrower being that a financial situation causing the Federal Reserve to raise rates dramatically (see 1980, 2006) would effect an immediate rise in obligation to the borrower, up to the capped rate.