Mortgage Borrowers Play a Bettor's Game

"Once a buyer identifies the home they want to bid on, it's hard to back down just because the rate has risen," he says. "Now with some home buyers unable to obtain the same loans at the higher rate, they'll be seeking an alternative, and the only recourse available is the lower-rate adjustable."

An ARM is cheaper, but it's not always right for every buyer.

McGee says many buyers, particularly first-time ones who will likely move within five years, can do well with an ARM. The most vulnerable are buyers without the income to meet the higher payments after over-leveraging themselves with bigger loans at attractive ARM rates.

"To be fiscally responsible, you would not necessarily borrow the maximum you can at an ARM rate," she says. "It's inevitable that the rate will go up and then it's more than you can afford. That's just not smart."

"It tends to be a very personal decision," says Walter Maloney, a spokesman for the National Association of Realtors. "If you know you're going to move within the next five years, it might make a lot of sense to have an ARM. That's particularly true for first-time buyers who anticipate a rise in income."

The threat to buying power represented by a rising interest rate is substantial, notes Melissa Cohn, owner of the Manhattan Mortgage Co. She says average 30-year fixed rates for the New York metropolitan market have jumped nearly 1 percentage point in two months.

Every one-percentage point increase in interest rates mean a 10% drop in buying power. For instance, the $1,798 monthly payment on a $300,000 mortgage at 6% goes up to $1,995 on a 7% note. That's a big difference.

"As rates go up, more and more people are going to go to an adjustable rate to qualify [for a mortgage] and afford their home," she says. "But if you're going to be there the rest of your life, even though fixed rates aren't as low as they were, it's still not a bad opportunity."