By Kirstin Downey
Washington Post Staff Writer
Saturday, March 25, 2006

With home prices so high, many buyers are looking at the new kinds of loans that have emerged on the market. Is a non-traditional loan the right way to go?

Glenn Schwartz, a loan officer with Vision Mortgage in Rockville, says yes, if you have good financial self-discipline. Allen Fishbein, housing expert at the Consumer Federation of America, says maybe -- but only if you understand you could get walloped by a big payment increase in the future.

Mortgages once came in only one variety: fixed rate, for 30 years. You paid the loan off over a lifetime, and lived rent-and-mortgage free in your golden years. That kind of ownership has provided important financial stability to today's senior citizens, many of whom own their homes outright by the time they retire.

Adjustable-rate mortgages, or ARMs, move up and down as interest rates rise and fall. They first became popular in the 1970s, when interest rates shot up. Lenders give borrowers lower rates at the beginning, but homeowners bear the risk that if rates rise, their payments will climb, too.

In the past two years, some new loan types have been added. They include interest-only loans, which can be fixed-rate or adjustable, and allow the borrower to avoid paying principal on the debt owed. Another variant is called "option ARMs," which permit borrowers to decide how much to pay and whether they want to pay down the principal or just the interest. At some point, these loans "reset," which means they begin requiring borrowers to pay both interest and principal, an increase that could double the payment.

All these loans permit lower payments, but if borrowers pay only the minimum amount, they could see the amount owed on their mortgages grow, not shrink, and could end up with less equity. Schwartz believes that sophisticated borrowers who plan to sell within a few years should get 10-year interest-only loans and use the money to invest in other ways.

Fishbein, however, said buyers with interest-only loans could find themselves in serious jeopardy if interest rates rise and property values fall. Then, these homeowners could find themselves facing steeply higher payments -- and unable to afford to sell their homes.

"We don't think people understand the toxic environment," he said.

Schwartz and Fishbein both agree that option ARMs are a risky bet for homeowners, although Schwartz said they might be a good deal for investors who want to buy a property, minimize their expenses while they fix it up, and quickly resell.

The Office of the Comptroller of the Currency, the federal agency that regulates most lenders, is mulling over the question. It is expected to issue a warning to bankers soon about which kinds of borrowers are good risks for these loans and which are not.