Mellody's Math: Zero-Percent Financing

The main benefit of a zero percent-down mortgage is that it can enable a person to purchase a home now instead of having to wait to save for a down payment, which could take years. While this can present a tremendous opportunity for many people, there are downsides to consider as well. To begin with, the interest rate on a zero percent-down loan will be higher than that of a conventional loan -- approximately a quarter to half a percentage point more, depending on your situation. In addition, you will have no equity in your home, which means you may end up owing more than your home is worth if property values decline even slightly.

Mellody's Math:

A half percentage point on a $150,000 mortgage is real money. Consider this ... the average interest rate on a 30-year fixed mortgage is currently 5.50 percent. So, if you were to pay 0.50 percent more (i.e., 6.00 percent), you will be paying an additional $48 a month and $17,150 more in interest over the life of the loan (assuming a 30-year fixed mortgage)!

Also remember, if you put less than 20 percent down on a home, you will be subject to private mortgage insurance, which can add another $100 or so to your monthly expenses.

ARMed With Options

The latest fad in ARMs is one with an introductory interest rate close to zero percent. While these "teaser rate" loans start off with an interest rate of 1 percent or zero percent, the rate generally rises to 4 percent or more after a short period of time (often between one to three months). Most of these low- or no-interest-rate ARMs are offered through a mortgage product known as an option ARM, which is becoming increasingly popular. In fact, in California, the country's largest mortgage market, option adjustable rate mortgages now account for more than one-fifth of all home loans.

Generally, with an option ARM, a borrower has four different payment options to choose from each month:

A minimum payment, which is less than an interest-only payment and usually does not pay down any principal.

An interest-only payment, meaning you simply pay the interest owed that month.

A payment that simulates a 30-year fixed mortgage.

A payment that simulates a 15-year fixed mortgage.

Typically, the minimum payment is the lowest payment option and is fixed for the first 12 months of your loan. After the 12-month period ends, the minimum payment is adjusted based on current interest rates and other factors, with most lenders capping the increase (or decrease) at 7.5 percent (this cap is usually waived every five years in an effort to put the borrower back on track to pay the loan off over the original 30-year period). Keep in mind, while minimum payments adjust annually, the payment amounts for the other three options will fluctuate much more frequently. Specifically, interest rates can adjust as often as every month after the introductory period ends, leading to fluctuations in payment amounts.