Watch Your Step, Novice Home Buyers...

I knew the real estate market was getting out of control the first time I opened my email in-box and noticed that come-ons to take out a mortgage were outnumbering those for Viagra.

Yes, it is tempting to read ads that promise me a $550,000 loan for only $888 a month, or $229,861 at 3.05%, to mention just two that recently arrived in my email. And isn't it nice that the senders offered to "preapprove" me for a loan? Especially since I never met these alleged loan officers.

Spammers, of course, prey on our lusts. When the lust for cheap money starts to outweigh simple lust, we should take it as a sign that we're all in trouble. And when it comes to indebtedness, we are. According to Economy.com, accounting for inflation, household debt has more than doubled since 1990, while household income has risen only 11%.

Cheap money is the enabler of what has become an addiction to borrowing. Even though interest rates are at near-historic lows, home prices have risen so fast, they're still not affordable for many people. So, creative financing deals from past decades are reappearing: siren-song loans that offer zero interest, interest only, no down payment, no closing costs and many other variations. ("Subprime" mortgages, made to people with less-than-sterling credit, now account for more than 10% of all mortgage debt.)

Of course, there is no "free" loan as far as a lender is concerned -- whatever you don't pay upfront, you'll have to pay later.

A Lender's Tale

Ellen Bitton, chief executive officer of Park Avenue Mortgage Group with offices in New York and Palm Beach, Fla., has seen a lot of changes in her 20 years as a lender and mortgage broker. Some of them she finds "upsetting." A decade ago, when rates were in the 7% and 8% range, only wealthy people took out risky loans like interest-only mortgages, she says. They used the money they saved on the mortgage to fund investments with higher rates of return, not to pay other bills. And if rates should go up? That might mean downsizing from a Maserati to a Lexus, but it wouldn't be a financial catastrophe.

Now, she says, "every Tom, Dick, and Harry is getting these loans, but they're not suited to everyone. Not everyone understands that rates can go up, or that equity can go down. Instead, they think, 'This is fun, cheap -- I can afford more house.'"

Saddest of all, she says, is that when everything inevitably comes to a head, the youngest and most vulnerable homeowners will be hurt most. Older homeowners remember 14% and 15% mortgages two decades ago and are wary of risky loans.

And first-time borrowers also are too young to remember the bad old days of the early 1990s, when risky lending and a recession led to lenders' portfolios being stuffed with foreclosures.

Then and Now

Not too long ago, lenders wouldn't give you a loan to buy a house unless you'd saved 20% of the price for a down payment. Most people got fixed-rate mortgages.

Big changes began in 1995, when Fannie Mae and Freddie Mac, government-sponsored entities that buy mortgages and repackage them for resale, began to offer automated systems to evaluated borrower risk. By 2001, consumers could access their own credit scores through the Web site myFICO.com, a consumer division of Fair Isaac, the company that spawned the FICO credit-risk score. Finally, the veil was lifted. Borrowers didn't have to go through white-knuckled interviews with bankers to see what loans they might get. They could apply for loans at midnight in their underwear through such online bankers as E-Loan and Lending Tree.

The Interest-Only Gambit

As home prices rocketed, buyers began looking for lower monthly payments. A growing number choose interest-only loans instead of amortizing ones, which front-load most of the your mortgage interest payments into the early years of the loan while more of the later payments go toward reducing principal.

Interest-only isn't one type of loan. It's an option that can be added to any kind of loan, from 30-year fixed to one-month adjustable. What it does, simply, is to put off the payment of any principal for a certain time, typically five, seven or 10 years. You can control a property and deduct the interest paid. But because you aren't paying toward your principal, you don't build any equity, unless the value of your home rises. At the end of the interest-only loan period, the balance becomes due.

Roaring Twenties

Interest-only loans were the norm in the Roaring Twenties. Back then, they weren't interest-only for a certain period, but for the life of the loan. People just kept paying interest until they sold their homes, when, they hoped, appreciation would cover the cost of the mortgage and maybe provide a little profit, too. If they stayed in their homes a long time, they refinanced endlessly. When home prices fell during the Great Depression and wiped out equity, interest-only loans fell out of favor.

Nowadays interest-only payments are especially popular with first-time buyers as home prices outpace their incomes. Usually offered at rates comparable with standard loans -- or a little higher, typically around a quarter of a percentage point -- interest-only mortgages have lower payments in the early years. That's because you're deferring payment of any principal. For a $250,000 30-year loan at 6%, the principal and interest of a standard, fully amortizing loan is $1,498. The monthly payment for an interest-only loan for the same amount is $1,250. Savings: $248.

Pinch Comes Later

But there's a price to be paid. If not refinanced or paid off, interest-only loans typically become "fully amortized" after a set period, and you have to pay both interest and principal, plus the principal you deferred. That's when your wallet really feels the impact.

If the interest-only loan in the above example becomes fully amortized after 10 years, the monthly payment will suddenly jump to $1,791 for the next 20 years, because you're paying both the regular and the deferred principal in a more compressed period. So to save $248 a month from the cost of a standard loan for the first 10 years, you have to pay $293 a month more for the next two decades.

This is fine if you plan to sell your home before the interest-only period expires (and home prices haven't dropped in the meantime), or you're so sure that rates will go down that you'll be able to refinance, or you expect a big fat raise, or you have a surefire investment that brings better after-tax returns than the cost of the loan, or you're really, really lucky at bingo.

Write to June Fletcher at june.fletcher@wsj.com