No matter which type of home loan you choose, the way the interest rate is calculated should play a prominent role in making your decision. It is fairly easy to figure out that you want a low interest rate, but is the home loan with the lowest rate always the best choice?

Home loan companies discuss their products' interest rates in terms of APR, or annual percentage rate. This is how many dollars you will pay for every hundred dollars of principal you will owe in a year if you make no payments on the principal of your home loan. Of course, it is a rarity not to pay down the principal of a home loan for an entire year, but the number is still a useful tool for comparison.

Some home loans use a fixed interest rate. Fixed rate home loans apply the same APR throughout the term of the loan. This means that the lender is able to calculate the total amount the home loan will cost the borrower and divide it by the number of payments. This allows the lender to provide the consumer with an accurate estimate of monthly home loan payments. These loans are generally the best choice for most lenders, particularly when interest rates are low. Borrowers should remember, however, that if there is an escrow account which is used to pay expenses such as property taxes or insurance, monthly home loan payments may still fluctuate slightly according to these expenses.

Adjustable rate mortgages (ARMs), sometimes called variable rate home loans, recalculate the interest on the loan periodically. Usually, the interest rate on an adjustable rate home loan at any given time is based on the interest rate at which the Federal Reserve is lending to financial institutions. Because the interest rate changes with the market, payments on these loans may fluctuate greatly.

Fixed rate mortgages are most popular when interest rates are low, because the consumer will still be paying a low rate when those taking out new home loans and those with variable loans pay much higher rates. When, on the other hand, rates are high, many consumers get variable rate home loans and plan to refinance into a fixed rate home loan after rates have fallen again.

Those who do not plan to remain in a home for very long, or who expect their household income to increase substantially sometimes choose balloon home loans. These loans are a hybrid of fixed rate and variable rate home loans. These home loans feature a low, fixed rate for an introductory period of several years, after which the rate becomes variable. While there are some situations in which balloon home loans are ideal, consumers who do not understand how balloon loans work, or who do not have a concrete plan for selling, refinancing, or increasing income by the end of the introductory period should avoid balloon home loans.