Growth of Interest-Only Market Raises Red Flags.

San Francisco -- The secondary market is beginning to question the unbridled growth of interest-only mortgages, 40-year loans, pay-option adjustables and other products designed to capitalize on the rapid run-up in housing prices.

Interest-only loans "have a place, but where we get nervous is their suitability to the borrower," Thomas Lund of Fannie Mae said at the Mortgage Bankers Association's National Secondary Market Conference here last week.

Such loans may be appropriate for some borrowers, but they could prove disastrous for those who are relying solely on skyrocketing values" to build equity, Mr. Lund told the conference.

Borrowers are "not saving much" in the form of lower monthly payments "in relation to the potential for an upward adjustment" in their interest rate and monthly payments a few years into the mortgage, he warned. And the trade-off could prove disastrous if they can't afford to take the hit.

According to the MBA, 11% of all loan originations in the second half of 2004 were IOs. And that's in addition to the 42% share, which were traditional and hybrid adjustable-rate mortgages.

"It's big, it's too much," chief economist Douglas Duncan told Mortgage Servicing News. "In some markets, the share is much higher than that."

Donald Disenius of Freddie Mac said he also is beginning to worry about IOs, particularly when consumers use their mortgages to accumulate wealth through appreciation rather than amortization.