Pricey home, dicey mortgage

With the median home price in the Golden State nearing half a million dollars, it's no wonder that fewer than 1 in 5 Californians can afford to buy a home. But plenty of people are snapping up high-priced houses anyway, on both East and West coasts, thanks to a burgeoning number of nontraditional mortgage loans.

Can't afford a $100,000 down-payment on a half-million-dollar home? Get a separate loan at a higher rate and borrow the money. Think you'll be richer down the line? Pay just the interest on your loan for a few years. Scared of high monthly payments? Get an adjustable interest rate that will stay low, at least for a while.

It's a far cry from the days when 20 percent down payments and 30-year fixed-rate mortgages were the norm. Now, in overheated housing markets, everyone from real estate agents and brokers to home buyers is saying that extreme times call for extreme measures. And why not do what it takes to buy a home when prices in some places are rising $1,000 a day?

But not everybody is so optimistic. A small band of skeptics is warning that homeowners are setting themselves up for a financial fall. If interest rates go up and home prices dip, owners may be forced to sell their homes at a big loss, some experts warn.

"I'm nervous about it," says Elaine Worzala, professor of real estate at the University of San Diego. "I do worry about the borrowers in markets such as this one, where homes are so expensive."

Her cautions are mostly ignored. To many aspiring homeowners, the housing market is issuing a clarion call they can't resist. In some parts of California, everyone seems to know someone whose home has skyrocketed $50,000 or even $100,000 in value in just the last year or two.

The median price of a single-family home in the San Diego region - half the houses cost more, half cost less - has reached $583,000, compared with $430,000 a year ago. Or check out Orange County to the north, where median prices jumped from $496,000 to $649,000. Overall, the California Association of Realtors estimates that only 18 percent of state residents can afford these prices. In New York's metro area, the median house now costs $392,000; in Boston's, $366,500; in metro Washington, D.C., $352,000.

Although there are signs that several local real-estate markets are cooling, "people act like we're going to run out of homes - if they don't buy now they'll be left out forever," says Dan Ruiz, a mortgage broker who specializes in assisting Latino buyers in southern California.

Because many of his clients can't afford to pay tens of thousands for a down payment, nearly all borrow the money, Mr. Ruiz says. And no wonder: With median-priced homes in California running at $463,000 as of July, residents must make at least $110,000 a year to afford a traditional 30-year fixed-rate loan with a down payment of 20 percent, the realtor association estimates.

In popular "80-20" or "100 percent financing" loans, potential homeowners borrow 80 percent of the purchase price of a home at one rate and the other 20 percent at a higher rate.

Down payments used to be virtually mandatory "because the banks wanted you to have money in the investment to protect themselves," says Professor Worzala. But now, the complex world of mortgage securities allows more flexibility.

Adding to potential risk, buyers in California and elsewhere are turning to "interest-only" loans. By paying down only their interest for a few years, they keep initial payments low.

Variable-interest-rate loans also woo potential home buyers. In many "hybrid" loans, the interest rates are fixed for the first few years, then can go up in the future, although the amount of increases is typically limited.For example, a homeowner might pay a fixed 3 percent interest for the first few years, with future increases limited to two percentage points a year or six points overall. The interest rate in this case, therefore, would never go above 9 percent.

Sound reasonable? Lyndon Garcia thinks so. He had his eye on a $355,000 fixer-upper in the Los Angeles suburb of Whittier, but he didn't make enough as an environmental project manager to afford a $70,000 down payment. An 80-20 loan with an adjustable rate and interest-only payments was just the ticket.

"There are so many positives to it," Mr. Garcia says. "Overall, it's an excellent plan. It helps the little guy."

At least for now. But what if interest rates go up, increasing monthly payments under adjustable rate mortgages? Combined with lower home prices - something experts have been predicting in California for months, if not years - they could spell disaster.

"A lot of people are already spending 50 percent of their income on their mortgage payment," says Worzala, the real estate professor. "If the interest rates go up, they're all of a sudden very cash-poor, putting themselves in a position where they have to default on their loan and lose their house."

Borrowers will be in especially bad straits if they haven't begun paying down the principal on their loans instead of the interest. "What's the incentive of staying if you have no equity?" Ruiz asks.

But to new homeowners like Garcia, who bought his home with the help of Ruiz, the risk is worth it. Thrilled about his new house, he thinks his complicated mortgage loans are a "win-win."