Want an Interest-Only Loan? No Problem

That's the opposite of how a regular mortgage works, in which initial payments consist mainly of interest on the borrowed sum, with a small fraction in the early years going toward reducing the debt. After all the payments are made, the homeowner in fact owns the property.

But with an option ARM it works in reverse, until at some point the repayment portion of the mortgage must begin. Then monthly payments can jump massively, possibly forcing the borrower into foreclosure.

Here's how:

Looking at the example of the Countrywide loan: After five years, the principal on the negative amortization loan offered by Countrywide would grow to $603,677 if only the minimums were paid. At that stage, the fully amortized monthly payment on the remaining 25 years of the loan would jump to more than $4,000 a month, TheStreet.com estimates. Countrywide didn't specify the required monthly payment for such loans, and the local representative who put together the examples declined to comment.

But a steep jump in loan payments is only part of the problem with negative amortization loans. If the homebuyer had put down only 10%, and the property value failed to rise, the borrowed amount would exceed the property's market value. That's a factor that would make it very hard to easily exit the loan by selling the home, something cash-strapped "owners" could once do when prices were rising.