During the recent unprecedented  boom in housing prices,  adjustable-rate mortgages, or  ARMs, became a popular option.

To make monthly payments  more affordable,many lenders offer  these loans whose interest rates are  tied to an index and can change  when that index changes. ARMs have  lower interest rates, and thus lower payments,  than traditional fixed-rate loans,  but when interest rates in general rise,  so do the rates on ARMs.

“It is the perfect loan for people  whose income is going to increase in  the next few years substantially, or for  someone who is probably not going to  stay in a house for more than a couple  years,” said Dan Vessely, president of the  Iowa Bankers Mortgage Corp.

But now, with interest rates  increased, many of these borrowers  have recently seen, or soon will see,  their mortgage rates adjust higher for  the first time, making their payments  double or even triple.  Foreclosures on ARM loans rose to a  four-year high of 2.19 percent in the  third quarter as borrowers struggled to  pay mortgage bills when their monthly  payments increased, the national Mortgage  Bankers Association reported.

But Vessely said, in Iowa, the effects  of both the housing slump and the “payment  shock” associated with ARMs will  be very limited.

“I’m not saying you won’t  have horror stories,” he said. “But  we haven’t seen a major problem  here in Iowa. Home prices are  holding steady, and if that holds true,  people will have no problem either refinancing  their mortgage or selling the  home to pay off the debt.”

Dave Horak, an account manager at  Mortgage Guaranty Insurance Corp. in  Urbandale, said the greatest effect will  be on borrowers in markets like  Phoenix and Denver, where home  prices skyrocketed three years ago,  making many homes too expensive for  the average home buyer. But with an  ARM, many were able to get into a  home that typically would be out of  their price range.

“But when the housing market  slowed down, those homes lost value,”  he said. “And now here we are three  years later, and the payment  has adjusted to  match the new interest  rate and they don’t have  enough equity to refinance  or sell the home.”

Horak agrees, however,  that this scenario is  not what’s happening in  Iowa.

“People need to realize  that the market is still  very strong,” he said.  “Home values have not  declined and interest  rates are still very favorable  compared to 10 or  12 years ago.”

Vessely said many people  have become worried  because of a lot of recent  media attention surrounding ARMs. But  most banks are more than happy to  work with a homeowner to avoid foreclosure,  he said.

Many lenders are taking new steps to  assist homeowners and help them avoid  falling behind on payments, or worse,  going into foreclosure, he said. Many banks now allow some borrowers to  refinance into a different type of loan at  no cost, alert homeowners with  adjustable-rate loans  months before the  rate is reset and allow  a house to be sold at a  loss and forgive the  remaining debt.

“Any lender will  do their best to try  to keep people in  their home,” Vessely  said. “Foreclosure  isn’t a good option  for either side. As  long as you’ve built  equity in your home,  there should be no  problems.”

ARMs can still be  a good option for  many people, Vessely  said, especially if  interest rates hold steady or decline in  coming years.

“Most ARMs come up for adjustment  after three years, so we’re starting  to see a lot of people’s payments  go up,” he said.”But I still don’t foresee  a major issue in Iowa because of the  strong housing market.”

Horak said he doesn’t know if he  would recommend an adjustable rate  mortgage in today’s market, only  because there isn’t enough benefit  with current interest rates.  “The short-term rates aren’t that  much lower than where fixed mortgage  rates are,” he said.”So I can’t see  the benefit.”

Vessely said other types of loans,  such as interest only, where borrowers  pay only the interest for the first  few years of the loan, or minimum  payment loans, where borrowers pay  a smaller payment and any interest  not paid each month is added to the  principal, are also available to potential  home buyers, but are not nearly  as popular.

And because the unpaid interest is  added to the mortgage balance, many  end up owing more on their mortgage  than they originally borrowed.

In the end,ARMs can be a gamble.

“You’re betting that interest rates  won’t go up exponentially,” Horak  said.”And you’re betting that housing  prices are increasing. Really, it’s all  about timing. That’s the number one  thing.”

Many people believe, Horak said,  that because Federal Reserve system  policy makers have been consistently  raising interest rates, the next logical  step is to hold them steady and possibly  even lower them. This could make  an ARM an attractive option for some  home buyers willing to take a risk.