Some investment promoters claim they have all this covered. They ask you a series of questions about your risk tolerance before they sell you their products:

“If the market declines 25 percent in one year, will you take your money out?” _ “Are you able to keep the long-term in mind when markets fluctuate or are you more comfortable with investments that do not fluctuate?” These tests determine your so-called “risk tolerance.” Risk tolerance is your ability to handle volatility. Risk tolerance tests are supposed to match you to compatible investments. Unfortunately, they don’t.

Risk tolerance is not a good measure of investment compatibility. At best, it measures a narrow aspect of your personality: your theoretical ability to handle volatility. Even if your broker happens to sell the product that is theoretically right for your risk profile and you buy it, studies show that how people think they will react under adverse market conditions and how they actually react are quite different. In fact, few of us know ourselves well enough to know how we would really react in future unknown situations.

In the runaway real estate market, adjustable-rate mortgages were everyone’s best friend. With interest rates that were significantly lower than fixed-rate mortgages, homebuyers could purchase a larger and more expensive home for the same payment as a fixed-rate mortgage. Mortgage brokers and real estate agents loved them because they could sell you a bigger house and earn a bigger commission.

Of course, there is just one small problem with adjustable-rate mortgages … they adjust! When the rate finally goes from 3–4% to 8–9%, your mortgage payment might double. That’s a huge adjustment for any budget—especially if you didn’t see it coming.

Adjustable-rate mortgages come in two primary types, all of which can leave a homeowner between a rock and a hard place:

Balloon mortgages. The monthly payment on these mortgages looks like a 30-year mortgage payment. However, a balloon mortgage requires the entire mortgage balance to be paid off after a short period of time, usually seven years.

7/1 or 5/1 mortgages. These mortgages have a lower rate for the first 7 or 5 years, after which the rate adjusts every year for the remaining 23 to 25 years of the loan!

Though the statistics vary by study, it’s estimated that one quarter to one third of all home purchases are made with adjustable-rate mortgages. In the beginning, adjustable-rate mortgages were designed for people who thought interest rates were going to go down within a few years of purchasing a home, or those who thought they would move within 5 to 7 years. Someone in either of these situations would benefit by not being locked into a longer 30-year fixed-rate mortgage.

If you plan on being in your current home for more than 5 to 7 years, or you think interest rates will stay the same or climb, you need to think about getting a better loan.

Once upon a time, a fixed-rate mortgage was the only real option. It may have taken some folks a few years to get to the point where they could qualify for one, but once they did, they were in a good, predictable situation.

In essence, a fixed-rate mortgage has one interest rate for the entire life of the loan. While this interest rate may not be as low as the adjustable-rate mortgages that have contributed to the housing crisis, it’s predictable. Owners are not likely to be caught off guard.

Most fixed-rate mortgages have either 15- or 30-year terms, but are often “refinanced” or replaced, with other fixed-rate mortgages when interest rates decline. It’s likely that homeowners will need to try and convert their adjustable-rate mortgages into a fixed-rate mortgage. That stability is key to diverting money to take care of other kinds of debt.