Want an Interest-Only Loan? No Problem

Washington Mutual and Bank of America point out that such loans are certainly not for everyone, and that they represent only a small portion of the total credit extended. In addition, Washington Mutual also says it made option-ARM loans only to prime borrowers.

Many of the loans in question go well beyond adjustable-rate debt or even "interest only" borrowing. Many fall under the rubric of "negative amortization mortgages," but also are often called "option ARMs." Those borrowers making only the minimum payments run the risk of quickly dropping into subprime territory, especially if they had taken the loan because they couldn't afford the standard 30-year mortgage with a higher monthly payment.

You might have seen these types of loans offered, but didn't know it at the time. Internet ads proclaiming "$300,000 mortgage for under $719/month" generally fall into the category because the monthly payment wouldn't even cover the interest.

"Any loan product for which your payment doesn't cover the interest will become a negative amortization loan," says Jean Fullerton, a personal-finance adviser at Lodestone Financial Planning in Manchester, N.H. With a negative amortization loan, the shortfall between the amount paid by the homeowner and the sum needed to cover the interest is added to the overall total, so over time the borrower effectively gets further into debt.