Understanding mortgage contracts and terms
By Elizabeth Razzi • Bankrate.com

As you read reports of borrowers who were surprised when payments on their adjustable-rate mortgages shot up from introductory teaser rates, or who were thwarted in their attempt to refinance because they discovered that their current loan has a stiff prepayment penalty, you might start to wonder if any such surprises lurk in your own mortgage. Dust off the old loan documents and look for some of these key terms, in case you have lingering doubts. If you are applying for a new loan, discuss these points with your loan officer.

Fixed-rate or ARM?
If it says your rate is fixed, check to see how long it will remain fixed. Thirty years? Five years? Six months? Unless it says 30 years (or more), you have some type of adjustable-rate mortgage, or ARM.

If it is an ARM, look for three things: the index, the margin and the adjustment or reset period. The index will be something widely published, such as the rate on one-year Treasury securities or a Federal Reserve cost of funds index called the COFI. Check the current rate for the various indixeson Bankrate's Rate Watch page. The lender will add a markup, called the margin, which could be 2 or 3 percentage points or it could be twice that or even more for a borrower with poor credit. The index plus margin determines your new interest rate. Look for caps on how much that interest rate can change at each adjustment period and over the life of the loan, and make sure the caps limit the interest rate charged, and not just the payment that can be collected. The adjustment period will tell you how frequently your interest rate will change.

Some ARMs allow convertibility to a fixed-rate loan at some point. This is a valuable feature, and borrowers typically have to pay extra for it. Look for this word in your loan documents, or ask your loan officer if you're not sure whether your loan has this feature.