Negative amortization
For homeowners already stretched to the breaking point, the mortgage reset will be catastrophic.
But there's something even worse: negative amortization.

Regular amortizing loans pay off part of the principal each month, and eventually the borrower owns
the home free and clear. But negative amortizing loans add to the principal each month. The loan balance
literally gets larger each month.

Large percentages of recent buyers ranging from California and Florida to Washington and Virginia will
face an additional shock because they took out a negative-amortization loan. Nationally, about 10% of
the loans taken out in the past two years had negative amortization, including about 24% of the loans in
California and 29% in the Bay Area.

These loans allow buyers to make minimum payments that don't cover all the interest due each month.
The interest that isn't paid is added to the principal. The shocker comes when the principal grows
to a pre-determined level (perhaps 110%, or 115% of the original loan) and the loan is "recast" immediately
as a fully amortizing loan, in some cases resulting in a doubling of the monthly payment.
This comes on top of any scheduled reset of the mortgage rate.

Negative-amortization loans were most popular in the areas with the fastest-growing prices during
the real-estate bubble. Now most of those same areas have experienced falling prices, meaning the
house may be worth less than what the owner owes the bank.

Even among those who believe the credit problems in the mortgage market will have a big economic
impact, only a few economists are calling for a full-fledged recession this year. But they all
think the risks are rising.

Rex Nutting is Washington bureau chief of MarketWatch.