'Exotic' mortgages tempt more buyers

The cheap mortgages that fueled America's real-estate boom are beginning to hurt the homeowners they once helped. Higher interest rates and the end of honeymoon periods for too-good-to-be-true teaser rates are causing payment shock for those who said "I do" to exotic loans.

Some homeowners are switching to safer, and slightly costlier, fixed-rate loans.

But others are taking on even more risk by opting for ultra-low payments that actually increase the loan balance. The result: A growing number of Americans have little equity in their homes, making them vulnerable to a housing slump.

"Because you don't accumulate any equity in your house when you take out these interest-only mortgages, if house prices don't go up, or go down, then you have negative equity, and a lot of these people who had speculated are going to lose money," says Jack Guttentag, a professor of finance emeritus at the Wharton School of the University of Pennsylvania, who provides mortgage advice at mtgprofessor.com. "There could be a rise in the foreclosure rate."

Signs of slumping home values became more evident this week in some regions. In Massachusetts, the median price for single-family homes fell 2.4 percent in January from December's prices. In California, values nudged up just 0.5 percent.

Mr. Guttentag and others acknowledge that nontraditional loans help many people afford homes. But mortgage ads, they say, often emphasize only the low, introductory rates. Consumers often get stuck with risky loans, ignorant of the complex factors that could raise their payments down the road.

"A lot of people who've taken on exotic loans don't understand them," says Scott Hanson, a senior financial planner at Hanson McClain, based in Sacramento, Calif. "The mortgage industry has sold these loans as a way to buy more house than you'd otherwise afford. Anyone who goes out today and gets an adjustable rate has got to be loony."

A year ago, however, it didn't seem so loony, particularly in premium real estate markets such as California. With home values skyrocketing, buyers tried to maximize the purchase - and minimize the monthly payment - with lower-cost adjustable-rate mortgages (ARMs). During periods of double-digit price appreciation, like most of last year, that strategy can pay off, either through selling for a quick profit, or by tapping into the home equity as a source of income.

But when values stall, as they now seem to be doing, those prospects disappear. Instead, buyers may face mounting difficulties. Many cheap loans carry flexible-payment options, such as interest only, or even negative amortization, which can increase the homeowner's debt load.

Those flexible-payment options used to be the province of the very wealthy. But during the real-estate boom, brokers marketed them aggressively to regular home buyers as a way to improve cash flow or finance a second home.

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