6/16/2005
The Trillion-Dollar Bet
By David Leonard and Motoko Rich
The New York Times

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Many borrowers stand to benefit from these creative loans. On option ARM's, buyers with variable incomes, like the self-employed, can also make smaller or larger payments depending on their take-home pay in a particular month, without incurring penalties. With the average homeowner moving every six years, any loan with lower initial payments can substantially reduce housing costs.

"As a rule, I would prefer the 30-year fixed mortgage," said Alejandro Brown, 31, a technical trainer for Nissan, the automaker, who refinanced the mortgage on his 1,700-square-foot house in Auburn, Wash., with an adjustable-rate loan last year, reducing his monthly payments. But, he said, "I knew I wasn't going to be in my house more than three years; I was very confident."

All of these loans come with the risk of a spike in payments sometime in the future. In particular, borrowers who have taken out an interest-only loan will see a jump in payments simply because they will start to owe principal after the interest-only period lapses. If rates rise, the payments will go even higher.

Borrowers whose incomes have not risen enough or who have not planned for the higher payments could find themselves shocked.

"The apparent froth in housing markets may have spilled over into mortgage markets," Alan Greenspan, the Federal Reserve chairman, said while testifying to Congress last week. "The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages, are developments of particular concern."

The lure of such loans is obvious. Because of the lower initial payments, buyers can purchase bigger and more expensive houses.

With her daughter leaving for college this summer, Linda Thompson decided to sell her four-bedroom house in the Seattle suburbs and move to a town house in the city's Lake Union neighborhood. But prices were so high that she had to go beyond her "level of comfort," she said, and spend $619,000.

She signed an interest-only mortgage that cut her monthly payments by about $500 compared with a conventional mortgage. Seven years from now, the bill will rise as she starts paying principal, and the size of the increase will be determined by interest rates at the time. But she may have moved by then, she said. And because the house is in an up-and-coming neighborhood, she expects the value to rise.

"The risk factor - of course it's always there," Ms. Thompson, 49, who runs a small marketing company, said as she was preparing to watch her daughter graduate from high school yesterday. "But to me, real estate is a better investment than the stock market."

"Just sitting there," she said of her new house, "it's appreciating right now."

Still, even some mortgage brokers are concerned by how much their clients are stretching their spending power using creative mortgages.

One possible warning sign is that a growing share of those taking out the aggressive loans is made up of lower-income families living in expensive areas, according to Economy.com, a research company. Another is that variable-rate mortgages have stayed popular even as long-term, fixed rates have gone down and rates on adjustable mortgages have risen .... continue to page 3