Real Estate prices began a wild ride beginning in 2001 until this year. Many thought it wasbecause of supply and demand. I disagree. The prices went wild because mortgagebrokers and Wall St.found a way to increase the buying power of a monthly payment through increasingly exotic (another way of saying crazy)  and nonsensical loans. The below chart explains themonthly cost for a $100,000 loan based on four different types of loans: fixedrate, ARM (adjustable rate mortgage); interest only and, my favorite. the payoption arm. (A pay option arm begins at a low initial interest rate – 1.5% -which is effective for less than 2 months. Thereafter, the interest rate on the loan fluctuates but usually increases to a variable interest rate of 7% or higher. The catch is that your payment stays the same as if the interest on the loan is still 1.5% but it is not. Since you are being charged 7.% interest but you are only paying interest at the rate of 1.5% each month the interest not paid by you is added to the principal balance of the loan. This is commonly known as negative amortization. These loans cap the negative amortization at no more than 15%-25% of the original principal loan amount.)    

The effect of each new loan twist was to increase the principal amount for the same payment amount.

The use of the exotic loans also assured that anyone who obtained one would be back shortly to refinance because when the loan adjusted, the homeowner could not afford the new payment. In selling these loans, there was no requirement that the homeowner be shown to be able to afford the increased payment that would inevitably flow from these types of loans. The mortgage brokers could come back every two years and sell the homeowner a new loan, and make fees all over again, to save the homeowner from the true cost of the loan the homeowner was previously sold.

* rounded up to $600 for illustration purposes. For instance the actual amount due for a $100,000 loan at 6% is $599.55.