Mortgage Activity Up, Rates Flat

On a $750,000 mortgage, as an example, a 30-year, fixed-rate loan at 6% would have a monthly payment of $4,496. With the pay-option loan, the 1% payment would be $2,400 and the interest-only payment would be $2,465. Paying less than the interest-only amount would lead to negative amortization, or money being added to the principal owed.

These loans are typically offered by savings and loan institutions, which keep them in their portfolios, such as World Savings Bank, a subsidiary of Golden West Financial (GDW Quote), Washington Mutual (WM Quote) and Indy Mac Bancorp (NDE Quote).

They are appealing to homeowners with variable income, such as the self-employed, those in construction work and those who rely on bonuses for much of their income, said Morrison. He said the loans are popular mainly because the prices of homes and the cost of living in Southern California far outstrips most people's incomes.

Interest-only loans, in which the borrower keeps monthly payments low by paying interest and no principal, are still popular as well with homeowners sending children to college or trying to repay credit-card debt, said Morrison. These loans, which can be resold on the secondary market, are offered by such major lenders as Bank of America (BAC Quote), Wells Fargo (WFC Quote) and Countrywide (CFC Quote).