Lambs to the Slaughter

From the New York Times:

"There are people who are buying homes that they shouldn't buy," said Eric Appelbaum, president of the Apple Mortgage Corporation in Manhattan. "People are saying, I can afford it on interest-only but I can't afford it" with a traditional mortgage, Mr. Appelbaum said. "It doesn't make any sense."

Since borrowers with interest-only mortgages are not yet paying down their debt, they are hoping to build up equity through an increase in home values. If house prices fall, as they did during the early 90's in some cities, borrowers will be forced to bring money to the table when they sell.

Even if home prices rise a little, borrowers who have taken out option ARM's and made only minimum payments for five years could find themselves in a hole. Such loans, which are typically based on rates that adjust monthly, give homeowners four payment options each month. In the first quarter of 2005, 70 percent of option ARM borrowers made the minimum payment, according to UBS.

In doing so, those borrowers effectively added more debt to the back of their loans.

[snip]

The biggest concern, many economists say, is that the new mortgages have come onto the market at a time when low interest rates and rapidly rising home prices are the only reality many people can imagine. Families might be making decisions assuming that combination will last forever.