Recent loan innovations allow home buyers to put little money down and make low monthly payments. They’ve also poured fuel one of the hottest and longest housing booms in the nation’s history. But in the wake of the Federal Reserve’s push to take away easy money, low interest rates and red-hot home prices have faded away. With them went the main conditions that made interest-only and other flexible mortgages worth their risks. So the consumer’s love affair with such loans is drawing to a close now, right?

Wrong.

Far from just another financing fad, exotic mortgages have become such a fixture on the U.S. housing landscape that they’ve proven to be a key lever for many borrowers even as they have become a greater danger at same time.

"In our changing market, from unprecedented low rates to a steady rising of interest rates, these varieties of loan programs have become much more popular," says Bill Callanan, a partner with Mortgage Management Systems, a San Francisco mortgage broker. "But if you’re scraping nickels together, they’re not for you." While traditional long-term, fixed-rate mortgages remain the loan of choice for the majority of home buyers, more borrowers are also shopping for interest-only loans, pay-option ARMs and hybrid fixed-ARM loans.

That’s particularly true in high-cost housing markets, where taking one of those loans may be the only way to afford a house. It worked well when double-digit home-price gains built equity while leaving more cash in homeowners’ pockets. Low interest rates muted the potential sting of upward rate adjustments.

But neither of those conditions exist today: Interest rates are well above year-ago levels and home-price gains have cooled or, in some of the hottest markets, already started to erode. One big problem, says Callanan, is that household incomes haven’t been rising as fast as interest rates, creating greater affordability hurdles for home buyers. Borrowers who use these loans now are challenged more than ever to gauge the health of home prices in their area and measure their ability to stay on top of payments, and to know when to refinance.

Paying off

For some, the gamble still pays off. Regardless of the health of the housing market, say mortgage experts, increasingly savvy consumers want more control over their own finances, including being able to invest money that would otherwise be tied up in a mortgage.

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