Q. I am divorcing, and our current home is on the market. I have found a condo I'd like to purchase for $152,000. I would put 30% down, and am anticipating a loan of approx. $125,000 at 5.75% to 6.5%. I would pay off my auto loan of $13,000 with divorce proceeds, leaving me with no outstanding debts, and a small cash cushion in addition to a 401k. My current income is $38,000, with roughly $2,000 to $2,100 take home after all deductions. I foresee a mortgage payment, including principal, interest, taxes and insurance, of approx. $1,000 per month.

First question: In reality, am I in a sound position to purchase a home at this time, as opposed to renting at about the same monthly rate?

Second question: Would I be better off with a fixed rate or an ARM?

A. Most lenders urge homebuyers not to spend more than 28% of their gross -- or pre-tax -- income on housing. So if your gross income is $38,000, that means you could afford to spend $10,640 a year or right at $900 a month. That's in the ballpark of the $1,000 a month you're expecting to spend on "principal, interest, taxes and insurance."

But it would be a tight financial squeeze and you should ask yourself these questions before buying:

• Are you including a monthly condo fee in that $1,000? Given that principal and interest on a $125,000, 30-year, 6% loan is $749 a month, we suspect not. But every condo has fees and that needs to be included in your monthly housing costs.
• If you are paying $1,000 a month for housing, and it could be more with the condo fee, you'll only have about $1,000 in take home pay left to live on. Can you do that? Would you be able to do it if you had to add a $200 or $300 a month car payment a few years from now? Can you do it without running up big credit card bills -- and balances?

You are in good financial shape with very little debt and some savings. You don't want to jeopardize that by spending too much on housing.

You could lower your payments slightly with an adjustable rate mortgage. But rates for 30-year fixed mortgages and ARMS are exceptionally close right now. In our latest weekly survey the average 30-year fixed-rate loan was 6.31% while the average five year ARM was 6.13%. That only works out to a savings of $15 a month on a $125,000 loan.  

Q. What's your outlook on option ARMs? My fiancé and I are planning on borrowing $450,000 for a home. We make a combined income of about $90,000 annually, and we take home $5,200 monthly after taxes. We feel we can afford principal and interest payments of $2000, and insurance and property tax payments of $700 to $800 a month. From what I understand, the option ARM is the only plan offered to get us the payment we'd feel comfortable with. Any advice?

A. Don't do it.

Option ARMs are the most dangerous mortgages around. They have gotten so many homebuyers into financial trouble.

These kinds of loans usually offer borrowers four different payment options each month. Lenders typically tout the cheapest of these, or the minimum payment, when convincing you to buy an option ARM. Borrowers love what they hear because the amount is substantially less than for every other type of home loan. But there are reasons for that.

The minimum monthly payment that sounds so enticing isn't enough to cover the interest being charged on your loan, much less repay any of the principal (the amount you borrowed.) The unpaid portion of the interest is added to principal, which means that each month you make the minimum payment, you're falling deeper into debt. Lenders also lower the initial minimum monthly payment by starting borrowers out at an artificially low interest rate that begins readjusting upward in as little as one month.

As a result, many borrowers find the minimum payment they were counting on begins rising almost immediately. Not only is the interest rate is going up, but the principal on which the interest is calculated is growing as well. At some point -- and terms vary widely from lender to lender -- the loan will essentially eliminate the option to make a minimum payment. You'll be required to pay all of the interest and begin repaying the principal. That's when the big shock comes.

You say you are able to spend $2,000 a month on principal and interest. But that's how much the interest alone would be on a $450,000 loan at 5.35%. That's lower than the market rate for any type of loan right now. A fixed-rate 30-year jumbo loan (loans over $417,000 are called jumbo loans and carry higher interest rates) is currently averaging 6.57%. Even if you could qualify for a better than average rate of 6.25%, the interest charge would be more than $2,300 a month.

So please, think very, very hard before signing up for a loan where the monthly payments could quickly grow beyond what you're expecting and you aren't budgeting enough to pay back the principal.

Have a question about your finances? Ask us at editors@interest.com.

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