MONEY: MAGICAL NEW MORTGAGES

The federal reserve is expected to raise interest rates this month--but for home buyers, that seems like old news. Rates on 30-year fixed mortgages have jumped nearly a full point since March, to 6.24 percent. That's driven the monthly payment on a $200,000 loan up by $114. Rising rates usually force home buyers to downsize their aspirations. But Paul Fein of mortgage lender GMAC sees many of today's buyers opting for a different strategy: instead of settling for a smaller home, many are still buying their dream house by taking out mortgages that are structured to offer lower monthly payments, at least early on.

They're able to do that because one-size-fits-all mortgages have been replaced by financing that's increasingly customized to meet home buyers' needs. The most common way to lower a payment is by choosing an adjustable-rate mortgage (ARM), which offers lower initial interest rates. Today ARMs account for 34 percent of new mortgages, up from 12 percent in 2001. Many buyers are choosing so-called hybrid ARMs, which keep rates fixed for the first three, five or seven years before floating in lock step with short-term rates.

The popularity of ARMs may seem odd, given that mortgage rates remain very low by historical standards. But economists say there are still smart reasons for choosing an ARM. The spread between fixed and adjustable rates has widened recently, forcing borrowers to pay a bigger premium for the certainty of a payment that won't change. And in a society where families change homes frequently, folks are realizing it may not be worth paying more for a rate that stays fixed forever. For a family that plans to own a home five years, a seven-year ARM is a fixed-rate loan, since they'll sell the house before the rate rises, notes Mortgage Bankers Association economist Doug Duncan. Even Alan Greenspan has suggested Americans are too fond of fixed-rate mortgages.

A newer kind of "interest-only" mortgage lets home buyers cut payments even further. Borrowers pay no principal in the early years of the loan--a period that often stretches to 10 years. That trims initial monthly payments dramatically. Consider that same $200,000 fixed-rate loan, which costs $1,230 a month over 30 years. An adjustable-rate interest-only loan at 3.38 percent cuts that payment by more than half, to just $563 a month. At HomeBanc Mortgage Corp. in Atlanta, more than 50 percent of home buyers opt for an interest-only loan.

They'd better know what they're doing. After the interest-only period ends, borrowers face a big jump in payments. With interest-only loans it also takes homeowners much longer to build up equity; if housing prices fall, they could end up owing more than they own, especially if they put down a zero down payment. That's one reason some pros think they're a bad idea. "They're a way to help people buy more house than they really should be buying in the first place," says Dallas financial planner Bryan Clintsman. Mortgage companies admit borrowers need to be aware of the risks. Says HomeBanc senior VP D. C. Aiken: "If they go out and buy a new car because they're saving $700 a month, that's not a good thing."

As rates rise, homeowners will face harder choices about which loan is right for them. At Countrywide, for instance, you can pick from more than 100 varieties of mortgages. But even as flavors multiply, making the right choice depends mostly on how long you'll stay in the house, and whether you're comfortable with the risk of your rate jumping around. "If you plan on being in a home for 10, 15 or 20 years, why wouldn't you take a fixed rate?" asks Melissa Cohn of the Manhattan Mortgage Company. Even in a world filled with new things, often the best choice is an old standby.