High-Risk Mortgages Become Toxic Mess

The Countrywide Banking and Home Loans office is seen in Glendale, Calif. in this April 26, 2007 file photo. While most of the mortgage market worries so far have focused on the huge losses flowing from the subprime home loans made to people with bad credit, the option and interest-only ARMs held by more creditworthy borrowers loom as another calamity in the making. The conditions have deteriorated so much that Angelo Mozilo, chief executive of mortgage lender Countrywide Financial Corp., recently described the current real estate slump as the worst since the Depression ended nearly 70 years ago. (AP Photo/Damian Dovarganes, file) (Damian Dovarganes - AP)

That means many ARM borrowers unable to afford their higher loan payments after their loans reset probably won't be able to extricate themselves by selling their homes. And refinancing into a more manageable mortgage is becoming increasingly difficult as suddenly leery lenders stop accepting application in an effort to avoid further headaches.

"It's a perfect storm that is going to lead to more foreclosures with severe downward pressure on home values," said George McCarthy, a housing economist with the Ford Foundation.

Martin doesn't think she is upside down on her loans yet, but knows she is getting uncomfortably close as home prices around her neighborhood continue to sag.

When Martin refinanced the mortgages on her home and two rental properties in October 2004, she said she owed a total of $735,000. The combined debt now stands at $777,000 and is growing by more than $2,000 each month.

Martin says she would have never refinanced if a mortgage broker hadn't misled her about how the new loans worked _ a frequent complaint among borrowers with option-ARMs.

As she contacts lawmakers and attorneys in search of help, Martin isn't focused on retirement any more. She is more worried about making sure she won't lose her home.

"I very well may be looking at a foreclosure case," she said. "I may just have to walk away from these loans."

Martin's situation isn't unique.

Although they have been around since 1981, option-ARMs weren't common until the past few years. They previously had been aimed at high-paid workers who depended on large commissions and bonuses.

But option-ARMs began making their way into the mainstream in 2004 as commission-hungry brokers and profit-driven lenders tried to capitalize on intense home-buying demand driven by soaring real estate prices.

Last year, negative amortization loans accounted for 9.9 percent, or $350 billion, of all mortgages nationwide, up from just 0.4 percent as recently as 2003, according to LoanPerformance.

The mortgages were particularly popular in high-priced real estate markets like California or areas like Nevada, Arizona and Florida, where speculators were buying homes as investments instead of places to live.