"2/28" and "3/27" mortgages are a good way for consumers with less-than-perfect credit to buy a home and improve their credit score.

They're certainly a 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.

What makes them attractive is that the initial rates are usually lower than for 5/25 ARMs and 30-year, fixed-rate mortgages offered to subprime borrowers.

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 what most borrowers with good credit scores pay on their ARMs.

But the idea is that homebuyers who use 2/28 and 3/27 loans will make their monthly payments on time, become a much better credit risk, and be able to refinance to a lower-cost, 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, as about 70% of subprime mortgages have prepayment penalties, compared with about 2% of conventional loans. But it shouldn't be a problem as long as the penalty expires before the interest rates begin resetting or your job doesn't require you to relocate to another city.

Unfortunately, lenders that made lots of ill-advised subprime loans over the past several years are now suffering from a wave of missed payments and foreclosures.

They're swinging to the other extreme and cutting off credit for consumers with poor scores. Several major providers of subprime loans, including Wells Fargo, Washington Mutual, Option One and First Franklin, have recently stopped offering 2/28 ARMs, 3/27 mortgages, or both.

While that will make it tougher to find one of these loans don't give up until you've shopped around with rates and terms varying 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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