6 mortgage rip-offs to avoid

Again, the best way to find a square-shooter -- and a good deal -- is with referrals and background checks. Also, make sure you're upfront about your financial situation. Most lenders assume your deal will be fairly straightforward and that you meet the following criteria:

• You have good credit.

• You have stable employment.

• You have a decent-sized down payment and enough cash to cover closing costs.

• You can document your income and assets.

• You're a U.S. citizen or permanent resident.

• You're buying a home you plan to live in (rather than rent out).

If any of these aren't true, you should let your lender or broker know in advance so you can get more accurate quotes.

You're going to end up owing more, not less, on your loan in a few years.

Most loans require you to pay down your equity over time, so that your balance shrinks a bit each year.

There are a few exceptions. Interest-only loans typically don't require principal payments for the first five to 10 years (for more details, see "Could you handle an interest-only loan?"). And some adjustable-rate mortgages allow what's called "negative amortization," where your balance can actually grow.

This is a feature of the newly popular "flexible payment" or "option" ARMs, which typically give you four choices of how much to pay each month.

One of the choices is usually a low minimum payment that may not cover all the interest that's accumulating on the loan. That unpaid interest is instead tacked on to your principal, so that your balance is getting bigger over time. This process is called negative amortization.

"You borrow $200,000," St. James said, "and five years later you owe $210,000."

There are usually limits to how much negative amortization you're allowed, however. Most loans that have this feature will automatically "reset" if your balance climbs to 110% to 125% of what you originally borrowed. That means your payments will suddenly spike, so that you're required to start paying down your principal. Borrowers who aren't prepared for this jump can wind up losing their homes.

Any time you get an adjustable mortgage, you should ask the lender for a schedule that shows how high your payments can go and how much you'll owe after five, 10 and 15 years. If you have more than one repayment option, ask for a schedule for each one. You want to see the worst-case scenarios, not the best. And don't listen to arguments that rates "won't" or "can't" hit their caps. Nobody can predict the future of interest rates.

I'm misleading you about your rate cap.

Here's another problem with flexible-payment ARMs: People are getting confused about their caps.

The typical ARM allows your interest rate to rise no more than 2 percentage points a year, or 6 percentage points over the life of the loan. A 1-year ARM that starts at 5.5%, for example, could jump to 7.5% in 12 months or a maximum of 11.5% by the fourth year.

But many people with flexible-payment ARMS think they have lifetime interest-rate caps of 7.5%, Moskowitz said -- either because they didn't understand what they were being sold, or they were deliberately misled.

What they actually have is a 7.5% payment cap. That means if their monthly payment is $1,000, it can rise to $1,075 in the second year, $1,156 the third year and so on.

"Their actual interest-rate cap might be something like 12%," St. James said. If the borrower's interest rate is rising more rapidly than the payments, the unpaid interest is tacked on to the principal amount -- creating the negative amortization discussed above.

Again, the best way to avoid surprises is to have the lender give you a schedule of payments that shows the worst-case scenarios. Then you can make an informed decision about whether this is the right loan for you.

Your 'no-cost' loan is going to cost you a bundle.

We're back to the adage, "If it sounds too good to be true, it probably is."

Every loan has costs: for appraisals, title insurance, underwriting, etc. The lender may be tacking the fees on to the loan principal, or charging you a higher interest rate than you would have paid had you covered the costs yourself.

In rare instances, St. James has seen lenders offer truly no-cost refinancings, where the borrower got a competitive rate and no fees were tacked onto the loan. But the deals were so-called "streamlined" refinancings for existing customers the lender didn't want to lose. If you walk in off the street, you're going to pay for the loan one way or another.

You might very well choose to pay a higher rate for a "no-cost" loan if you plan to be out of the home in a couple of years. But if you plan to stay longer, it's often a better idea to pay the costs out of pocket.

Liz Pulliam Weston's latest book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.

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