Mortgage brokers have begun promoting "2/28" and "3/27" loans as a way for consumers with less-than-perfect credit to buy a home and improve their credit.

They're well worth considering.

These mortgages are a much safer alternative to the dangerous option ARMs or "1% mortgages" brokers have pushed on subprime borrowers over the past several years.

They also offer realistic rates and terms that don't unduly punish borrowers for past sins and credit scores in the low 600s, or even the 500s.

Indeed, 2/28 and 3/27 loans have a lot in common with conventional three- and five-year ARMs that borrowers with good credit often use.

They offer a fixed, introductory rate for the first two or three years. After that the interest rate resets once a year over the remaining 27 or 28 years of the loan, based on what mortgages cost at the time.

While interest rates on conventional ARMs always start out lower than those for 30-year, fixed-rate mortgages, that's not the case for 2/28 or 3/27 loans. They're aimed at borrowers with poor credit, so expect to pay about 1 percentage point more than the average fixed-rate loan with comparable fees.

That works out to something like $67 a month more for every $100,000 you borrow -- a reasonable penalty for being a higher risk.

When rates begin adjusting, they can go up by no more than 2% a year and a total of 6% over the initial interest rate -- exactly the same as for most conventional ARMs.

But the idea is that homebuyers who use 2/28 and 3/27 loans will make their monthly payments on time, improve their credit scores and qualify for a very good, fixed-rate loan before their ARM begins to reset.

Borrowers definitely have a better chance to succeed with these loans than the loathsome option ARMs, which:

• Misled buyers into borrowing more than they could afford with ridiculously low "teaser rates" that were often less than consumers with good credit were paying for conventional ARMs.
• Began raising those rates almost immediately, often after just one or two months worth of payments had been made.
• Boosted rates every month, not every year, and raised them higher and faster than limits on conventional ARMs would allow.
• Encouraged borrowers to make a "minimum payment" that wasn't even enough to cover the monthly interest charge. The difference was added to the balance, which means borrowers were falling deeper and deeper into debt with every check they wrote.

You won't be subjected to any of that with 2/28 and 3/27 loans. Nor will you endure the payment shocks that caused so many homeowners with option ARMs to fall behind on their payments and face foreclosure.

These loans simply aren't as deceptive.

The one unattractive trait these mortgages share with option ARMs is that they usually come with steep prepayment penalties.

That's not surprising, about 70% of subprime mortgages have prepayment penalties, compared with about 2% of conventional laons. But it should be a problem as long as the penalty expires before the interest rates begin resetting and your job doesn't require you to relocate to another city.

Finally, be sure and shop around for the best deal, because rates vary a lot from lender to lender. A good place to start is our extensive database of the best interest rates on 2/28 and 3/37 mortgages from banks and mortgage companies across the country.

By Carolyn Siegel

Interest.com Associate Editor

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