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Homeowners in Harm's Way

Interest rates on mortgages that adjust annually, known as one-year ARMs, typically run between 1.5 and 2 percentage points below 30-year fixed-rate mortgages. Rates on one-year ARMs last year ranged from a low of just over 3.5 percent to 4.18 percent in December, according to data from Freddie Mac, the giant mortgage finance company. For February of this year, the rate was 4.16.

For all of last year, one-year ARMs averaged 3.9 percent, and for 2003 they averaged 3.76 percent.

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Thirty-year fixed-rate mortgages averaged 5.84 percent last year and 5.83 percent the year before.

At those averages, the monthly payment on a $250,000 one-year ARM would be $1,179.17, while on a fixed-rate loan it would be $1,473.26. So the appeal to a borrower who is near the limit of his or her ability to pay is clear.

But recent economic reports, including some on Friday, suggest that inflation may be accelerating, and Federal Reserve Chairman Alan Greenspan has made it clear that he intends to raise interest rates as aggressively as necessary to keep inflation in check. So far, the Fed's pressure has not caused dramatic changes in mortgage rates, but if rates return to the levels that might have been considered reasonable just a few years ago -- say, 7 or 8 percent -- ARM holders would face big payment jumps.

At 7 percent, the payment on that $250,000 ARM would be $1,663.26. At 8 percent, it would be $1,834.41.

A large number of ARM loans when rates are low "is a little worrisome," said David Lereah, chief economist at the National Association of Realtors. "It does indicate there are households out there at the margin leaning heavily on ARM rates to qualify for the house."

In addition, rising rates will put downward pressure on home prices because fewer buyers will be able to qualify for loans with bigger payments. Further, if some ARM borrowers become unable to meet their higher payments and therefore put their houses on the market, that will add to the downward pressure.

The result could be a serious slump in the housing market, and a lot of pain for some families.

But Lereah said the overall reality is very complicated.

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