Finding the right mortgage loan, like deciding on the right cell phone or the right digital camera, can involve way too many choices these days. The ads scream: Interest-only! No interest! Low, low introductory rates!
But the stakes are much, much higher when it comes to a home than when it comes to entertainment gadgets.
Knowing that your house is on the line if you take the wrong loan and can't keep up with the payments should be enough to get most of us to do our homework.
However, instead of asking questions about which loan best fits their financial situation, people in frenzied housing markets are leaping at the discount promises and then looking, consumer groups say. Those scrambling to get into a first home, to move up into an ever-more-expensive neighborhood or to grab a second home, and others who may simply be investors in search of the lowest monthly costs, often aren't factoring in anything but the initial payments, lenders say.
"People just don't listen to what they're getting when they hear loan offers today. They just want the lowest monthly payment," said Russell Rothstein of Beacon Mortgage in Rockville.
"The less educated they are, the easier it is for them to get taken advantage of," he said. "Plenty of educated people, depending on how busy they are," can also be misled by new loan types that might not be suitable, he said.
The problem, he and other brokers and lenders say, is how to get people to stop, look and listen.
Here's a guide to the new world of mortgage lending.
New Loans Complicate Process
* Interest-only mortgages. The most popular newcomers, interest-only loans, require payment of just the interest on the money borrowed rather than paying both interest and principal, at least at first. Monthly payments are lower than traditional long-term fixed-rate loans or ordinary adjustable-rate mortgages, known as ARMs, during the interest-only period, but rise sharply after the borrower starts paying off the principal. Another payment shock can come if interest rates spike at the same time.
* Option ARMs. "Payment-option" adjustable-rate mortgages, or option ARMs, are another popular choice, lenders say. These loans give borrowers several payment choices each month, including the choice to pay less than the interest owed.
If a borrower chooses to pay less than the interest owed, the result is a situation lenders call "negative amortization," which leaves the borrower owing more each month than was lent originally. If a borrower has to sell the house, he may owe more than the house is worth, even if home values have not fallen.
"Frankly we're a little concerned here about the popularity of the interest-only and no or low down payment loans," said Scott Walker of Alexandria Financial Associates in Virginia. "Everyone's situation is different, and they may be a good fit for some. But these kinds of loans can, I think, lead to people biting off more than they can chew."
* Forty-year mortgages. Loans that stretch the repayment period to 40 years from the traditional 30 years, but still offer a fixed interest rate, are also attracting some borrowers.
Forty-year mortgages have been around for years but drew little attention. They got a boost when Fannie Mae introduced a pilot program to buy them from credit unions a year ago. In June, Fannie said it would expand its purchases to all approved lenders. That has led some to speculate that the 40-year loan could take off if interest rates pop, because the loans appeal to conservative borrowers who might want to try an innovative product but shy away from those they perceive as risky.
The Mortgage Bankers Association says 40-year mortgages represent only 1 or 2 percent of loan originations and will never approach the other alternatives because borrowers have to pay thousands of dollars more in interest over the life of the loan.
But a lender in the pricey Cape Cod-Nantucket market in Massachusetts, who introduced a 40-year mortgage that resets to a new interest rate after 20 years, says consumers are responding. "Since we rolled it out a little more than a year ago, over 50 percent of our originations are 20/20 loans," said Michael Sinclair, vice president of the Hingham Institution for Savings in Hingham, Mass. "It's been very successful."
Red Flags Over Risks
Alarms are being raised nationwide about the risks of these new "exotic" or "specialty" mortgages because borrowers may not realize how much they will owe or may not want to consider the possibility that they are taking on too much house and that the rising prices of the past may not continue, consumer groups say.
Some of the most popular new loans limit monthly payments in the initial years but can require much larger payments later.
Among those waving red flags lately have been Federal Reserve Chairman Alan Greenspan, the Mortgage Bankers Association, the National Association of Realtors and the nonprofit Center for Responsible Lending.
Greenspan and the industry groups have taken particular care to explain that the new loans are not evil. They're often providing just what would-be home buyers want these days -- lower monthly payments that will let borrowers keep up with soaring prices.
Fannie Mae spokeswoman Sandra Cutts said about 60 percent of the loans on the West Coast are interest-only. In the Washington area, interest-only loans represented about a third of all mortgages written in the first half of the year, according to a survey by LoanPerformance, a San Francisco company that tracks loan originations.
The mortgage bankers' trade group also recently joined those cautioning borrowers to look before they leap.
Greenspan expressed concern this summer about the increase in such loans and suggested that buyers and investors may be using them for houses they really can't afford. He also warned borrowers and lenders that if interest rates jump or the housing market cools, "some households may have trouble meeting monthly payments."
The NAR and the Center for Responsible Lending last month said borrowers should take heed: Payments "could jump by as much as 50 percent or more when the introductory period ends," the groups said. They published a brochure explaining the pitfalls.
Choosing the Right Loan
The new alternatives are not risky for all borrowers, the lending and real estate groups say.
Among those who might benefit, according to lenders:
* Financially savvy borrowers who understand they may not be building equity and who choose to invest their monthly savings.
* Those who anticipate having higher income in the future to offset the higher payments.
* Those who expect to move before a short-term ARM adjusts.
"The two big questions," said Bob Walters, chief economist of Quicken Loans, are "how long are the borrowers going to be in the home and what is your objective?"
He said, "If the borrower is going to be in the home less than five years, it makes no sense to take a fixed-rate loan. Why pay interest for protection that you don't need?"
If the objective is to "pay the loan off as fast as you can with the lowest interest rate and not take on interest rate risk," then a traditional fixed-rate loan is a better fit, he said. "If your goal is to keep your payment as low as possible, then other products come in, like the interest-only loan."
If a borrower intends to move soon, an adjustable-rate mortgage with lower interest rates is the choice, said Janice Burgess of the Virginia Housing Development Authority. Her agency is offering a 30-year loan with a five-year interest-only period to eligible lower- and middle-income families. Maryland's Department of Housing and Community Development also offers 35- and 40-year loans with initial interest-only periods.
Burgess said, though, that borrowers should plan for the day when the real bills start to come due. "If you're going to be in a house longer than the interest-only period, you need to feel comfortable that your income is going to increase so that you can absorb the payment" when the principal gets added in.
"If you are in a market that is realizing significant appreciation, you may feel comfortable" that the value of the house will increase over the interest-only period and that it will be possible to refinance into a better loan, she said. "But if you're in a market that is not appreciating significantly, you will probably want a traditional loan."
Interest-only loans are particularly attractive to those who are paid by commission or in bonuses, because their income is erratic, Burgess said. In a slow period, they can come up with the lower payments. When they get bonuses, they can pay down the interest-only amount, reducing that loan, and pay down the principal, she said.
Another good candidate for an interest-only loan, said Daniel Rebibo of Mortgage One Inc. in Rockville, "is someone who can afford anything they want" and chooses not to pay principal because he wants to invest the savings.
"Rather than paying $3,000 a month for a mortgage and reducing their debt, a borrower may hear suggestions from a financial consultant to pay only $2,200 and invest that $800 somewhere else, like in a self-employment IRA or in buying a property here or there," Rebibo said.
Beatriz Yanovich, a Montgomery County real estate agent, fits the interest-only profile. She and her husband refinanced their Potomac home last month from a 30-year loan to a 10-year interest-only loan through Rebibo's company because Yanovich anticipates that her sales commissions will allow her to pay off the interest early and to apply money to the principal.
"If you think that five years down the road you'll be making the same income . . . this is not for you," said Yanovich.
Walters said interest-only loans have "been taking a lot of broadside shots in the media" but have pluses. A bigger question, he said, is whether borrowers taking advantage of such loans are disciplined enough to make good use of the savings. "If you run out to a casino and blow it" or run up credit card bills, "you lose. If you make good choices, you win."
Rebibo said he "personally does not like the interest-only product, because how do you guarantee that the property will go up in value in the coming year?" Also, he said, lower-income, credit-challenged borrowers are too often enticed into taking loans for more than they can afford.
Mike Calhoun, general counsel for the Center for Responsible Lending, said home buyers "should be cautious about accepting a mortgage they can't afford. These mortgages can be devastating for families who are stretching their budget to buy a home."
Dick Ueltschi, a retired government contractor in Centreville, recently refinanced his home with a five-year interest-only ARM. The barrage of come-ons for new loans, he said, can be "absolutely mind-blowing."
"I got a call about a year and a half ago . . . and I asked the guy all sorts of penetrating questions, I thought."
Then he spoke with a mortgage broker he had worked with before, Paul E. Skeens of Carteret Mortgage in Fort Washington.
"When I called Paul and said, 'Here's what he offered me,' he knew the product and what the potholes were in it."
Skeens told him an interest-only ARM was a bad idea, "till you can say for sure that you're going to be in the house for less than five years," Ueltschi recalled.
But a week ago, after Ueltschi could make that promise, Skeens gave him his blessing. Now, the retiree says he is using the money he is saving on the monthly mortgage to pay off a lot he bought at Wintergreen and to save for a new condo at Hilton Head.
Skeens said, "The basic rule that people follow today is 'What's my lowest possible payment?' and we'll worry about the loan amount later."
But by making "tiny little payments" to get into a house they can't really afford, he said, "they're basically mortgaging off more than their payments, they're mortgaging off their future equity."