The option ARM became very popular, and with the real estate rush that we experienced over the past years, it's no wonder how so many people became wrapped up in the many types of creative loans for buyers to choose from. However, the option ARM wasn't intended to be used by buyers who "wanted more house for their money" - it was created as a good choice for investers and homeowners who were not going to own the home for very long. But the majority of buyers who are now stuck with this type of loan were exactly the buyers who should have been wary of the option ARM.

But in reality, rates have begun to rise and home values are dropping in many areas, and the option ARM has become more of a danger than it looked to be in the past. With an option ARM, there are several choices for the monthly payment, but the choice that poses the most risk is to pay the minimum due. This would be a similar risk to paying your credit card off by simply making the minimum payments. If you pay the minimum paymnet on your credit card, you would end up with a balance that is greater than the original charges. This would be exactly the result on an option ARM in which the homeowner paid just the minimum payment option.

Most borrowers with the opton ARM are opting to pay just the minimum payment, and are putting their homes at risk. The minimum payment is usually calculated using the first month's interest rate, generally a low "teaser rate" as low as 1-2%. When the monthly payments are not even covering the total amount of interest that is accumulating, the balance of the loan continues to grow, while the value of the home may not be rising as quickly as the balance due. Any unpaid interest is added to the principal, and the total of both are then used to calculate future payments. This is called negative amortization, which can present only problems for both the borrower and the lender.

Now, more than ever, home equity loans have become the "thing to do". With credit cards holding interest rates higher than the rate on most mortgages, homeowners are have been looking towards home equity lines of credit (HELOCs) to buy the toys that they have always dreamed of. Now this may not sound like much of an issue to the untrained ear, but to those in "the know", there is a huge problem brewing in the real estate and mortgage industries. Home prices are beginning to drop in previously booming areas, interest rates slowly climbing, and a burst the number of exotic loans have increased the risk for homeowners, borrowers, and industry professionals. So why are so many mortgage professionals remaining calm? This type of build-up of financial burdens on homeowners brings about a perfect opportunity to cash in on the increasing need to refinance to keep their mortgage payments under control. According to Brad Brunts, with Citi Mortgage, these changes will bring him more business, "It offers an opportunity."

Freddie Mac estimates that Americans took $556 billion in home equity loans or cash-out refinancing programs. With little or no equity left in their homes, many homeowners will find that when their mortgage adjusts, that their payments could nearly double. This may even leave the borrowing homeowner with very few choices, and none of them good. The homeowners could choose to sell their home, but would most likely be in a position in which they owe more on the house than it's worth, and many similar homes on the market.

So is there hope? There is, take action before it's too late. In fact, it would be better to act on it before millions of other interest-only or exotic mortgage holders join the rush to dump their homes on the market.

The popularity of interest-only mortgages continues to increase as interest rates rise, but don't jump too quickly into this new mortgage scheme.  Financial services firm UBS AG analyzed loans being packaged into mortgage-backed securities and found that the volume of interest-only loans jumped from only $7.9 billion in 2004 to $38 billion last year. They now account for 8% of all new residential mortgages.

While the interest-only mortgage does look attractive because of the initial lower payments, your payments will jump dramatically when the interest-only period ends in 10 to 15 years. For example, a standard $300,000 30-year fixed rate loan at an interest of 6.62% (this week's average) would have a principal and interest payment of $1,920.  The interest-only loan rate is a bit higher at 6.75%, but the payment is much lower at $1,687.  That's because you won't be paying anything toward the principal of the loan initially.

Those lower payments may sound great if you're trying to buy a larger home, but don't get caught up in the hype of the interest-only loan.  Usually the interest-only period lasts for just 10 years.  If you don't sell or refinance before that time, your payments could jump by 35% to $2,281, when the interest-only period ends.  You will still have to pay the principal off in 30 years, but only have 20 years in which to do it.

If you do need to sell the home in the first ten years,  you'd better hope your home has appreciated enough to cover the costs of the sale, since you haven't paid down any of the principal of the loan.  If not, you may have to come up with cash to close the loan in order to pay closing and sales (real estate commissions) costs.

As interest rates rise, new mortgage applications continue to fall.  That's no big surprise.  Consumers quickly become uneasy about higher interest rates. 

The Mortgage Bankers Association reported that mortgage applications to buy a home fell for a second week in a row by 2.5%.  Refinance applications fell 0.4% to the second lowest level in a year.

The average rate for a 30-year fixed-rate mortgage hit its highest level in almost 4 years, since the week ended June 7, 2002.  The rate climbed to 6.56%, up from 6.5% a week earlier.

The good news for the economy is that as housing cools it will ease economic growth in the second quarter, which should slow inflation.  That ultimately will make it easier for the Fed to halt its drive to raise interest rates. 

Many homeowners who took advantage of low adjustable rate mortgages in the last couple of years should get ready for a major shock to their pocketbooks.  The Mortgage Bankers Association estimates that people holding about $330 billion worth of ARMs face interest rate adjustment in 2006 and $1 trillion worth of ARM holders will be impacted by the end of 2007.

What does that mean for you?  If you hold an ARM that you got when interest rates were 4%, the ARM is likely to increase by 2% to 6%.  Your monthly mortgage principal and interest payment would increase by $245 from $955 to $1,200.  Ouch.  That would hurt anyone’s budget.  If your property taxes increase as well, you’ll be hit by an even greater increase on your mortgage payment.

Unfortunately, if you’re in this boat, there’s not much you can do to get out.  Fixed rate mortgages averaged 6.49% at the end of last week.  If you do hold an ARM, get ready for the rocky road now and start cutting your other monthly expenses before you get hit with the payment change.

According to an industry trade group, U.S. mortgage applications rose last week, reflecting an increase in loan refinancing even though mortgage rates are at a threee-month high.

The group's seasonally adjusted index of refinancing applications increased 2.6 percent to 1,614.4 compared with 1,573.5 the previous week.

The MBA's seasonally adjusted purchase mortgage index fell 0.4 percent to 399.0 from the previous week's 400.8. The index was below its year-ago level of 451.7.