Mortgage Borrowers Play a Bettor's Game

"Our forecast has for some time anticipated that the Fed would wait until late this year before starting to raise short-term interest rates," Duncan said. "But the growth of the economy has accelerated and raised the likelihood of a near-term rate increase."

What a Difference a Year Makes

Based on the national average home price of $170,000, minus a 10% down payment, a $153,000, 30-year fixed rate mortgage at 6.32% would mean monthly payments covering principal and interest of $949.02. The same payment during the fixed term of an adjustable rate mortgage at 3.87% is 719.03, a 24% difference.

And in a housing market where new home prices are rising 5.5% this year and are expected to rise about 4% in 2005 and 2006, that helps stretch a buyer's reach

The danger is in the adjustment, which typically occurs after an interval of one, three or five years. For instance, in three years, if rates move to 8.6%, the monthly payment would leap to $1198.19; that's almost 40% more than the introductory rate payment on the ARM and 25% more than the monthly payment on the fixed-rate alternative.

Although conventional wisdom in the real estate industry suggests people move every seven years on average, meaning many properties bought on ARMs will turn over before rates rise, at least some of those buyers will overreach. That will contribute to a projected rise in foreclosures like the one that followed the spike in ARMs from 1994 to 1995 -- when the Fed essentially doubled the funds rate -- says Alexis McGee, president of Foreclosures.com, a distressed property investment advisor.

In part, the trend toward adjustable rates reflects homebuyers' refusal to temper their rabid appetite for real estate, sometimes at any cost. With buying power down, people are choosing an initially cheaper interest rate in order to come up with the money they need to make an offer, particularly in expensive markets, says Lawrence Yun, chief economist for the National Association of Realtors.