Naturally, this sounds like a "mean" way to do business, but in most cases this "commitment" period is what actually makes the loan, interest rate and payments affordable in the first place. The bank made a higher risk loan but still offered a below market rate; in return, we either pay them for the privilege over time (monthly payments) or pay it all at once (the "penalty"). In any event, prepayment period should NEVER, EVER extend past the Fixed Rate Period.

Lastly, ARM interest rates are NOT "controlled" by the bank. Interest rates are generally pegged to one of the publicly published mortgage market indexes such as the LIBOR, MTA and COFI. You can get an idea about how your ARM interest rate may change by looking these indexes up for yourself.

Remember: It's all about risk. When a bank lends $250,000, they are taking a big risk (with other people's money). The only insurance they have is your income, good payment history and - in the worst case of all, the property they secured the loan to.

The 2/28 mortgage is a class of home loan known as a "hybrid" Adjustable Rate Mortgages (ARM). "Hybrid" means the loan combines features of both fixed and adjustable rate loans; in this case the interest rate is fixed for 2-years (or 3, 5, 7, 10 and longer) and then begins adjusting (either up or down believe it or not!) on either a monthly, semi-annual or annual basis.

Responding to historically low interest rates, a sharply appreciating real estate market and millions of new homes for sale, bankers adopted this type of loan to give more people the opportunity to become homeowners. As rates began to rise in 2004, the 5-, 7- & 10-year ARM is also a viable alternative for well-qualified borrowers to purchase or refinance without paying the premium for a fully fixed rate (especially given the constant rise/fall cycle of rates).

As with everything, there are pros and cons to the 2/28:

THE GOOD: Generally, 2/28 interest rates have starting (or "teaser", like your credit card) rates well below the market for fixed rate products (usually 15- and 30-year). This means a borrower who might not qualify (due to credit, income or other deviations from standard lender guidelines) for a higher, fixed rate loan can still get their purchase or refinance money. Investors (a.k.a. "speculators" and "flippers") also used this loan heavily in recent times as their intention was not to pay off the mortgage, but instead buy and refinance/sell within a short period. From the banker's point of view, since this borrower carried more risk coming in, compensation came from a higher fee structure and a note rate that eventually adjusts back to market par.

THE BAD: After the initial fixed period (usually 1-3 years), the interest rate becomes variable, which since 2004 usually means UP (few mention the fact that ARM rates/payments actually went DOWN during 2002-04)! Obviously, a sharp increase in rate/payment carries the potential of financial distress for the borrower who may be unable to sell or refinance their way into relief, so there's your double-edged sword.

THE UGLY: Many 2- & 3-fixed rate loans carry a Prepaid Interest clause (a.k.a. "prepayment penalty") that stipulates the payment of interest (usually 6-month's worth) to the bank in the event the loan is paid off early (1- to 3-years usually). These clauses are generally stated clearly and plainly during loan origination, within the loan documents and verbally just before closing (they are not even legal in some states).