I read a lot of articles about why you should choose and Adjustable Rate Mortgage or an Interest-only Mortgage. Most of these articles promote them as a way to better leverage your money. In other words, you can get more house for a smaller payment. Admittedly it’s a great selling point by mortgage brokers and lenders. But have you ever asked yourself why these professionals are offering you this option?

In the past when you purchased a home you typically chose from one of three options: pay cash outright, get a 15-yr fixed rate loan or get a 30-yr fixed rate loan. For those who paid cash outright it was the result of many years of saving and/or part of an inheritance. There was no note. There was no debt.

Those who chose a 15-yr fixed rate loan were usually financially stable and had an income a bit larger than what they actually needed. Finally the 30-yr fixed rate people were also financially stable but may not have been able to afford as large a payment as the 15-yr people. Both of these groups would have to go to their financial institution and prove their credit-worthiness before receiving a mortgage.

However, in the 1990s lenders began to relax their standards. This allowed for more profit to be made by the lending agencies. In order to accomplish though they would have to approve sub-prime borrowers. Sub-prime includes those with bad credit histories and low incomes. Translation: They would approve you even if you couldn’t afford the home.

For those with low incomes the standard 15- and 30-yr mortgages were still unattainable because the monthly payments exceeded what they could afford. So lenders started pushing Adjustable Rate Mortgages. These mortgages came with the advantage of a lower monthly payment at the beginning (because the interest rate was lower) but the payment would climb with the rate of interest. The lenders were betting on two things here: your income would increase and interest rates would stay low long enough for you to establish your credit-worthiness in order to refinance with a traditional mortgage.

Interest-only loans are an entirely different monster. What you are doing is taking out a mortgage, usually for a 5-7 year period, where all you do is pay the interest. At the end of the term you will have the remaining principle due. These are sold on the idea that you may move before the loan comes due. These types of loans have been popular on both coasts for the past few years. However, with the economy stabilizing and the job market tightening it will become difficult to refinance these types of loans.

Why am I against ARM’s and Interest-only loans? Because they are gambles and are basically predatory in practice. Both rely on assuming your income will increase, your property values will increase and/or you will sell your home within 5-7 years. Based on these assumptions your lender will approve a loan you cannot afford today. Also, if you need to sell your home you will have to do one of two things: Price your home above market value in order to repay your loan or else lose money on the sale and take out a unsecured loan to pay off the difference between what you owed and what the home sold for.