Still a Home for Nontraditional Loans

Fixed Rates Are Fine for Most, but Alternatives, Chosen Wisely, Can Yield Savings

The mortgage mess that has unfolded in the past year has turned off many borrowers to nontraditional loans, especially the adjustable-rate mortgages that have been closely linked to a rise in foreclosures.

Nothing wrong with that.

But there's nothing wrong with adjustable loans, either -- or the much maligned interest-only loans -- if they are used properly. They are still available, and they still make sense for some borrowers.

"It's simply a question of suitability," said Ric Edelman, a financial planner in Fairfax. "For some people, these loans are excellent."

Finding the best-fitting loan means thinking through the options and speaking to as many professionals -- lenders, mortgage brokers, real estate agents -- as possible before making a decision. Choosing between fixed- and adjustable-rate mortgages is the first and possibly most important step.

Fixed-rate loans might not be best for everyone, but they are a sensible choice for most borrowers, especially given today's relatively low interest rates. Having predictable monthly payments enables homeowners to plan their budgets and insulate themselves from shock should interest rates rise.

These loans tend to carry a higher rate than adjustable loans written at the same time, though that gap is narrower than usual now. "Many borrowers are willing to pay the additional price for peace of mind, and that's fine," Edelman said, especially if they plan to live in the home for 10 years or more.

But for those who do not plan to stay in a home that long, adjustable loans might make more sense. They come with various features, including a choice of how long it will be before the rate changes -- one, three, five, seven and 10 years are common. A homeowner who expects to move in five years might be better served by a loan that resets in five to seven years. That loan would essentially function as a fixed-rate loan at a discount because of the lower initial rate.

Add to that a feature that allows borrowers to initially pay only interest, and the loan gets cheaper.

But when the interest-only period expires, borrowers must start paying down the principal. And for those with adjustable loans, rates can spike sharply once the loan resets.

This would translate to much higher payments. Borrowers should not take out these loans unless they can handle the worst case, said Barry Glassman, a financial planner at Cassaday & Co. in McLean.

"Never take out a loan because it's cheap in the early years," Glassman said. "That's what many people did in the recent past, and that's what's gotten them in trouble."