This is an archived article that was published on sltrib.com in 2007, and information in the article may be outdated. It is provided only for personal research purposes and may not be reprinted.

When Linda Martin refinanced the mortgages on three different houses nearly three years ago, she thought the lower monthly payments would help her save more money for retirement.

Instead, the Lakewood, Colo., skin-care specialist is sinking in financial quicksand amid a widening mortgage morass that's pulling down home prices and threatening to drag the U.S. economy into a recession.

''I'm hanging on by a thread, not knowing whether I am going to be living in a car in six months,'' said Martin, who declined to reveal her age.

Martin is among the hundreds of thousands of borrowers nationwide saddled with ''option'' adjustable-rate mortgages, risky loans that dangled bargain-basement, introductory payments and also let borrowers defer a portion of interest payments until later years.

Millions of other borrowers are wrestling with another type of adjustable rate mortgage, or ARM, called interest-only. These loans allowed borrowers to pay just enough each month to cover the interest owed on the loan, leaving the balance of the outstanding debt unchanged.

Although most of the mortgage market worries so far have focused on the huge losses flowing from the subprime home loans made to people with bad credit, the option and interest-only ARMs held by more creditworthy borrowers loom as another calamity in the making.

If the worst fears about these loans materialize, the economic damage would likely extend well beyond the United States because much of the debt has been packaged into securities sold to pension funds, banks and other investors around the world who were hungry for high yields. The fallout could also further depress housing prices, leaving U.S. consumers feeling poorer and less likely to buy the merchandise imported from overseas.

So far, less than 4 percent of the option and interest-only ARMs are delinquent, well below the 14 percent rate for the subprime market, where about $1.5 trillion in home loans are still outstanding, according to the most recent data from the research firm First American LoanPerformance.

But there is still reason to be alarmed because the trouble with option and interest-only ARMs still appears to be in its early stages. Many industry observers suspect the biggest problems will emerge during the next 16 months as shoddily underwritten ARMs made near the real estate market's peak in 2005 and 2006 climb to higher interest rates.

''Those loans are begging to blow up. This is a true financial crisis,'' said Christopher Thornberg, a principal with Beacon Economics, a consulting firm that has followed real estate market's ups and downs.

Lenders made an estimated $581 billion in option ARM loans during 2005 and 2006 while doling out nearly $1.4 trillion in interest-only ARMs, according to LoanPerformance. A recent study estimated about $325 billion of these loans will default, leading to more than 1 million homeowners relinquishing their property to lenders. By comparison, about $212 billion in subprime loans were delinquent through May.

The initially low monthly payments on these exotic ARMs enabled more people to buy homes and enticed other borrowers to refinance their existing mortgages to free up cash for other purposes.

Now, the exotic ARMs are tormenting overextended homeowners, reckless lenders and shortsighted investors as the teaser rates rise, dramatically driving up monthly loan payments against a backdrop of declining property values.

The conditions have deteriorated so much that Angelo Mozilo, chief executive of mortgage lender Countrywide Financial Corp., recently described the current real estate slump as the worst since the Depression ended nearly 70 years ago.

Countrywide sent out another distress signal last week in a regulatory filing that warned it's being forced to hold on to more loans than it wants to keep.

Washington Mutual Inc., another major lender of option and interest-only ARMs, echoed those concerns in a similarly bleak Securities and Exchange Commission filing that warned the subprime problems are cropping up in higher-quality mortgages, too.

Option ARMs such as Martin's are especially toxic when home prices start to shrivel.

When borrowers pay the minimum monthly amount on an option-ARM, they aren't covering the amount of interest accruing on the loan. To compensate, lenders add the amount of unpaid interest to the mortgage's outstanding debt.

Option-ARMs also allow for a higher monthly payment to reduce the loan's principal, but most borrowers make only the minimum installment. At some lenders, 80 percent to 90 percent of the option-ARM borrowers are paying the minimum amount.

So, a homeowner who originally borrowed $250,000 under an option-ARM could end up owing an additional $5,000 to $10,000 after making the minimum monthly payment for a year, depending on the terms.

The negative amortization isn't as troubling when home prices are rising because the borrower could still be building more equity than debt.

But now that real estate prices across much of the nation are sliding, the additional debt created by option-ARMs raises the chances that the property will be worth less than the remaining amount owed on the loan - a perilous position known as being upside down.

The situation becomes more worrisome as the teaser rates on the loans adjust upward.

It's a scary scenario because many borrowers obtained their loans with little or no down payment, meaning they only had a small amount of equity to start. Nearly 18 percent of the first mortgages originated last year went to borrowers with no equity in the property, up from 5 percent in 2002, according to an analysis by First American CoreLogic, a research firm affiliated with LoanPerformance.

That means many ARM borrowers unable to afford their higher loan payments after their loans reset probably won't be able to extricate themselves by selling their homes. And refinancing into a more manageable mortgage is becoming increasingly difficult as suddenly leery lenders stop accepting applications in an effort to avoid further headaches.

Although they have been around since 1981, option-ARMs weren't common until the past few years. But option-ARMs began making their way into the mainstream in 2004 as commission-hungry brokers and profit-driven lenders tried to capitalize on intense home-buying demand driven by soaring real estate prices.

The mortgages were particularly popular in high-priced real estate markets such as California or areas such as Nevada, Arizona and Florida, where speculators were buying homes as investments instead of places to live.

If many of those loans go bad, major option-ARM lenders probably will be forced to erase some of the profits that they have already booked from the exotic mortgages. Investors already appear to be seeking shelter from the possible financial storm ahead.

Washington Mutual's stock price has dropped by 21 percent so far this year, while Countrywide's shares have shed 34 percent. Another major option-ARM lender, IndyMac Bancorp Inc., has been even harder hit, with its stock plunging by 55 percent since the end of last year. The sharp downturn in those three stocks alone have wiped out a combined $24 billion in shareholder wealth.