Home loan plans fall into three simple categories: fixed-rate loans, adjustable-rate mortgages, and hybrid loans, which have features of fixed-rate loans and ARMs.

Fixed-rate mortgages have interest rates that don't change during the life of the loan. The interest rate on an adjustable-rate mortgage (ARM for short) adjusts every six to 12 months, or every month, depending on the terms of the loan. When interest rates fall, the ARM interest rate usually falls, but the opposite is true when interest rates increase.

Adjustable-rate mortgages "are tied to an index which is a measure of the lender's cost of borrowing money. As the index rises, so will the interest rate on the adjustable loan," according to Dian Hymer, author of "Buying and Selling a Home, A Complete Guide," Chronicle Books, San Francisco; 1994. Common indexes include Treasury Securities (T-Bills), Certificates of Deposit (CDs), and Libor (London inter-bank offering rate). Most metropolitan newspapers publish current ARM index rates.

The interest rate and payment adjustments may or may not be scheduled to change at the same time. For example, the interest rate on some plans changes more frequently than the monthly payment, which may result in negative amortization. "This means that the additional interest will be added to the principal balance of the loan and may accrue additional interest itself," Hymer says. If the monthly payments on an ARM are increasing, generally this is because the index is rising or it is a negative amortization ARM.

Introductory rates on ARMs are usually two or three percentage points lower than the fixed-rate. Because initial expenses will be lower with an ARM, a lender is more likely to lend you more money than with a fixed-rate loan.

Hybrid loans start with a fixed rate that's guaranteed for an established period, usually one to five years. After that period, the loan becomes an ARM.