Business Week looks at exotic loans. "For cash-strapped homeowners, it was a pitch they couldn't refuse: Refinance your mortgage at a bargain rate and cut your payments in half. New home buyers, stretching to afford something in a super-heated market, didn't even need to produce documentation, much less a downpayment. Those who took the bait are in for a nasty surprise."

"Many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules, often to the astonishment of people who thought the low installments were fixed for at least five years. And because home prices have leveled off, borrowers can't count on rising equity to bail them out."

"What's more, steep penalties prevent them from refinancing. The most diligent home buyers asked enough questions to know that option ARMs can be fraught with risk. But others, caught up in real estate mania, ignored or failed to appreciate the risk."

"There was plenty more going on behind the scenes they didn't know about, either: that their broker was paid more to sell option ARMs than other mortgages; that their lender is allowed to claim the full monthly payment as revenue on its books even when borrowers choose to pay much less; that the loan's interest rates and up-front fees might not have been set by their bank but rather by a hedge fund; and that they'll soon be confronted with the choice of coughing up higher payments or coughing up their home."

"The option ARM is 'like the neutron bomb,' says George McCarthy, a housing economist at New York's Ford Foundation. 'It's going to kill all the people but leave the houses standing.'"

"Gordon Burger is among the first wave of option ARM casualties. The police officer from a suburb of Sacramento, Calif., is stuck in a new mortgage that's making him poorer by the month. Burger, a solid earner with clean credit, has bought and sold several houses in the past. In February he got a flyer from a broker advertising an interest rate of 2.2%. If he refinanced the mortgage on his $500,000 home into an option ARM, he could save $14,000 in interest payments over three years."

"Burger quickly pulled the trigger, switching out of his 5.1% fixed-rate loan. 'The payment schedule looked like what we talked about, so I just started signing away,' says Burger. He didn't read the fine print."

"After two months Burger noticed that the minimum payment of $1,697 was actually adding $1,000 to his balance every month. 'I'm not making any ground on this house; it's a loss every month,' he says. He says he was told by his lender that he'd have to pay more than $10,000 in prepayment penalties to refinance out of the loan. If he's unhappy, he should take it up with his broker, the bank said."

"'They know they're selling crap, and they're doing it in a way that's very deceiving,' he says. 'Unfortunately, I got sucked into it.' Among Burger's alternatives were one for $2,524, about what a standard fixed-rate mortgage would be on the new amount, and the $1,697 he pays. Why would his bank make the minimum so low? Thanks to a perfectly legal accounting practice, no matter how little Burger pays each month, the bank gets to record the full amount."

"Most of the pain will be born by ordinary people. And it's already happening. More than a fifth of option ARM loans in 2004 and 2005 are upside down, meaning borrowers' homes are worth less than their debt. If home prices fall 10%, that number would double. 'The number of houses for sale is tripling in some markets, so people are not going to get out of their debt,' says the Ford Foundation's McCarthy. 'A lot are going to walk.'"

"After prolonging the boom, these exotic mortgages could worsen the bust. They also betray such a lack of due diligence on the part of lenders and borrowers that it raises questions of what other problems may be lurking."