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Published Dec. 1, 2006

The promise of low monthly payments has been irresistible in recent years as adjustable-rate mortgages offered a low-cost foothold in the once red-hot housing market or an easy way to tap into home equity.

But now the bills are coming due.

Millions of homeowners soon will face a financial nightmare brought on by a combination of higher interest rates, risky mortgages and a housing market gone cold. The result is likely to be a rising tide of delinquencies and foreclosures, particularly among low-income borrowers, although economists say it's too early to project how severe the situation will be.

Just a few years ago, adjustable-rate mortgages looked like a solution, not a problem. They made homes seem affordable when wages stagnated as prices soared. They were just the ticket for cash-out refinancings and home equity credit lines that bought cars and swimming pools and paid off credit card debt.

"What happened in a lot of expensive real estate markets is that first-time home buyers who felt they could not afford a home otherwise, took on a loan that had lower monthly payments than a traditional mortgage would have," said Allen Fishbein, director of housing policy for the Consumer Federation of America. "They weren't being underwritten on the basis of the borrower's reasonable capacity to handle these loans."

The payments started out manageable, especially since many loans offered teaser rates. But borrowers are getting a lesson in what the word "adjustable" means. More than $130-billion in mortgages have payments that will reset this year.

It couldn't come at a worse time. Housing prices have stalled or fallen in many areas and the market is flooded with homes that simply aren't selling. In the Tampa Bay area, there are more than three times as many homes for sale as there were a year ago and 40 percent fewer sales.

That means borrowers who can't afford their payments can't count on being able to sell their homes, while lack of price appreciation means many don't have the equity in their homes they need to refinance at a good interest rate. Both factors make foreclosures more likely.

"Mortgage delinquencies remain very low nationwide, but risks are stacked to the upside," said Gina Martin, financial economist for Wachovia.

Overall, 4.41 percent of mortgages are delinquent, up from 4.34 percent a year ago, but lower than they were three years ago, according to the Mortgage Bankers Association. Just 0.99 percent are in the foreclosure process. But for borrowers with poor credit, the delinquency rate in the second quarter was 9.17 percent for fixed-rate loans and 12.2 percent for adjustable-rate loans. A whopping 3.56 percent are in foreclosure.

While most outstanding mortgages are the fixed-rate variety (four-fifths by some accounts), adjustables have soared in popularity and have accounted for a third or more of new mortgages in recent years.

Martin said the increased use of adjustable loans and rising delinquencies are natural responses to changes in interest rates.

"It's a function of markets and the fact that interest rates were extremely low and consumers were willing to take a risk of jumping into a mortgage that resets in the future," she said. "But without a doubt there are some consumers that were not as educated as we would hope they would be with respect to what mortgage product they've gotten into."

Martin says home buyers should have learned about mortgages and understood the risks they were taking.

"Many borrowers are not aware of how high monthly payments can climb," said Fishbein at the Consumer Federation. "When interest rates increase and payments reset, payments could be 50 percent or more above what they were paying."

Connie Holt, 52, has gotten a payment jolt. The mortgage on the "dream house" she bought in New Port Richey two years ago started out at 6.75 percent interest. Her payments were fixed at $642 a month for the first two years. About six months ago, she got the news that her rate would reset to 9.75 percent, increasing her monthly payment by more than $200.

"I knew it was not a great loan. I was hoping interest rates were not going to tick up, but they did," she said. Holt, a systems manager, said that at the time she bought the house, her financing options were limited by her recent divorce. "I took the loan in hopes that within two years I could do something else. I've worked hard to build my credit back up."

Her story has a happy ending. Holt refinanced with Third Federal Savings, getting a 30-year fixed-rate loan at 6.15 percent interest and reducing her payment to $615 a month.

Refinancing will be a solution for many borrowers with adjustable- rate loans. However, others won't qualify for fixed loans at low rates because of credit problems or lack of equity.

A few years ago, the most popular type of adjustable was like the one Holt had. These are called hybrids because the interest rate is fixed for a certain number of years, then becomes adjustable.

However, those loans have given way in popularity to higher-risk varieties with lower monthly payments. About a third of new mortgages offer payment plans that don't build equity for the borrower. The most controversial and complicated of these are known as "option ARMs." Payments initially are fixed, but interest rates are not.

Initially these mortgages were pitched to investors and sophisticated buyers. Their flexibility particularly appeals to borrowers with fluctuating incomes.

"They are a very valuable product," said Patrice Yamato, president of the Florida Association of Mortgage Brokers. "For individuals who have a decent amount of equity in a house and are going to be living there less than five years, this may be an excellent vehicle."

Gulfport real estate investor Sarah Murphy uses the mortgages, but recognizes their danger: "Investors who are selling within a couple of years like these loans, but they can spell disaster in the current market in which overinflated taxes and insurance costs have crippled the homeowner's pocketbook and have scared off buyers."

Even for prime borrowers, adjustable-rate loans have a higher delinquency rate than fixed-rate mortgages. But in recent years option ARMs have been heavily marketed to home buyers with modest incomes. They account for nearly 13 percent of the mortgages issued in Florida this year and 9.5 percent of those issued in the Tampa Bay area.

The Consumer Federal of America analyzed more than 100,000 option ARM mortgages taken out last year and found that more than one-third of the borrowers had incomes of less than $70,000 a year. More than one-fifth had below-average credit scores. Hispanics were nearly twice as likely to use option ARMs than non-Hispanics.

Mortgage broker Don Fazio in St. Petersburg, said adjustable mortgages meet a real need for people with poor credit who do not qualify for low fixed rates.

"This gives them time to repair their credit, so in 24 months they would qualify for the optimum rates offered on a 30-year fixed term," he said. "To blame the selection of a product makes no more sense than blaming the Hummer for the miles per gallon it delivers. Pretty much, they should have known what they were getting into when they bought it."

Congress' Government Accountability Office said last month the government needs to improve disclosure requirements on riskier mortgages.

Helen Huntley can be reached at or (727) 893-8230.

Homes at Risk

Second of two parts

Nearly a third of Tampa Bay mortgages are the high-risk varieties, up from 10 percent just three years ago.