A fixed rate mortgage (FRM) is a mortgage loan where the interest rate on the note remains the same through the term of the loan, as opposed to loans where the interest rate may adjust or "float." Other forms of mortgage loan include interest only mortgage, graduated payment mortgage, adjustable rate mortgage, negative amortization mortgage, and balloon payment mortgage. Please note that each of the loan types above except for a straight adjustable rate mortgage can have a period of the loan for which a fixed rate may apply. A Balloon Payment mortgage, for example, can have a fixed rate for the term of the loan followed by the ending balloon payment. Terminology may differ from country to country: loans for which the rate is fixed for less than the life of the loan may be called hybrid adjustable rate mortgages (in the United States).

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 (including compounding frequency, amount of loan, and term of the mortgage). With these three values, the calculation of the monthly payment can then be done.

An adjustable rate mortgage (ARM), variable rate mortgage or floating rate mortgage is a mortgage loan where the interest rate on the note is periodically adjusted based on an index.^[1] This is done to ensure a steady margin for the lender, whose own cost of funding will usually be related to the index. Consequently, payments made by the borrower may change over time with the changing interest rate (alternatively, the term of the loan may change). This is not to be confused with the graduated payment mortage, which offers changing payment amounts but a fixed interest rate. Other forms of mortgage loan include interest only mortgage, fixed rate mortgage, negative amortization mortgage, and balloon payment mortgage. Adjustable rates transfer part of the interest rate risk from the lender to the borrower. They can be used where unpredictable interest rates make fixed rate loans difficult to obtain. The borrower benefits if the interest rate falls and loses out if interest rates rise.

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.

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.

This type of loan is also known and advertised as the "pick a payment" or "pay-option" loan.

When a borrower makes a payment that is less than the interest payment, there is negative amortization, where the unpaid interest is added back onto the principal balance.

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. When pricing an Option ARM, never focus on the Start Rate of 1% or 2%, consider only the Fully Indexed Rate (FIR) which is the Margin and the current Index being used (12-MTA, LIBOR, etc.).

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.

The function of the loan that can cause this payment shock is called the "Recast" cap. The recast will happen when the orignal loan balance reaches 110% to 125% of the original loan balance due to negative amortization of making the minimum payment.

For example: a $200,000 with a 110% recast cap will adjust to a fully indexed, fully amortized payment based on the remaining term of the loan when the negative amortization add to the loan balance reaches $220,000. If it was a 125% recast this will happen when loan balance reaches $250,000.

Obviously the higher the recast cap the longer it will take for the recast to take place and the more negative amortization can be added to the loan balance.

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, increase the chance that he won't be able to sell the property for an amount that will repay the loan.

Historically, option ARM mortgages have been used effectively to minimize income taxes and maximize mortgage interest deductions by high net worth homeowners whose earnings are primarily derived from passive or investment income. By making minimum payments over the course of a year, these borrowers are able to defer the majority of the income required to service their mortgage debt to the end of the year, allowing income brought in as a long term capital gain, and taxable at a favorable rate, to be used in making lump sum interest payments. High net worth individuals and real estate investors also have a long history of utilizing the negative amortization characteristics of these mortgages to their advantage to avoid taxation entirely on gains in real estate, by refinancing regularly to "take profits" from illiquid residential and commercial real estate equity.

Option ARM mortgages are increasingly available in Hybrid, or temporarily Fixed Rate varieties, from 3 to 10 years, mitigating certain negative amortization characteristics of the popular Adjustable Rate variety. Largely as a result of yield curve inversion, a handful of banks have introduced 30 year fixed rate mortgages with option ARM style minimum payments.

An interest-only loan is a loan in which for a set term the borrower pays only the interest on the principal balance, with the principal balance unchanged. At the end of the interest-only term the borrower may enter an interest-only mortgage, pay the principal, or (with some lenders) convert the loan to a principal and interest payment (or amortized) loan at his/her option.