Adjustable-rate mortgages can help overcome the high cost of housing, but disproportionate use of the loans by some groups is causing alarm among financial experts and consumer advocates.

The high cost of housing recently forced nearly 70 percent of home buyers in Silicon Valley to use adjustable-rate mortgages (ARMs)—one of the highest rates in the nation.

Ironically, the same high cost that drives home buyers to ARMs compounds the risk associated with them. Lower-income households, which can least afford the risks associated with ARMs, are also more apt to use an ARM to buy a home. Lower-income households, along with ethnic minorities, who reveal less knowledge about the risks of ARMs are more apt to use them than others.

"The good news is that about two-thirds of Americans not only prefer fixed-rate mortgages but appear well aware of the risks of ARMs," said Stephen Brobeck, executive director of the Consumer Federation of America, a Washington, D.C.,­based nonprofit consumer advocacy agency.

"The bad news is that lower-income and minority Americans are not only those most likely to prefer ARMs, but also those with the poorest understanding of their risks," he added, referring to a recent CFA study.

The study, "Lower-Income and Minority Consumers Most Likely To Prefer And Underestimate Risks Of Adjustable Rate Mortgages," couldn't be more timely. Interest rates have been trending up for the first time in years. When rates rise, so does the cost of ARMs.

The CFA study found that 37 percent of Hispanics and 31 percent of African Americans preferred ARMs, compared to 23 percent of whites. It also found that 33 percent of those with incomes of less than $25,000 preferred ARMs, compared with 20 percent of those with incomes greater than $50,000 who prefer ARMs.

In the study, all respondents were asked to estimate the annual increase in mortgage payments if the 6 percent interest rate on a $200,000, 30-year ARM—with annual payments of $14,400—rose by 2 percentage points to 8 percent.

A far higher percentage of Hispanics and African Americans (43 percent) and those with incomes of less than $25,000 (44 percent) than of all Americans (35 percent) could not estimate the increase.

It's not surprising that fixed-rate mortgages have been the cornerstone of the U.S. housing-finance system. They come with, well, fixed interest rates. The monthly mortgage payment remains the same month after month, year after year, for the term of the loan. A fixed amount is easier to budget for over the long term.

ARMs, on the other hand, are cheaper—at first. There are myriad ARMs and how much cheaper they are initially and how long they remain cheaper varies immensely, based upon how long the initial rate lasts (from about six months to 10 years) and based upon the size and frequency of subsequent adjustments written into the loan contract.

The cheaper initial rate can allow a home buyer to qualify for a mortgage that may have been out of reach with a higher FRM rate. A lower interest rate means a lower monthly mortgage payment.

Landing a lower monthly mortgage payment is the big reason 68.1 percent of Silicon Valley home buyers chose ARMs over FRMs as recently as November 2003, the last time La Jolla­based DataQuick examined the number of FRMs versus ARMs.

What's more, ARMs can indeed adjust down and get even cheaper, as many have in recent years.

In addition to the lower initial rate and the ability to become even cheaper, ARMs come with a little-known advantage attached to the lower rate. When mortgage-loan interest is cheaper, a smaller portion of the monthly mortgage payment goes toward the interest and a larger portion of the monthly mortgage payment goes to the principal. Theoretically, that can allow the borrower to gain equity faster than with a more expensive loan, because, as the loan's principal balance shrinks, equity grows. That's true, however, only as long as the interest rate remains relatively lower.

"We don't really focus on that as much as the danger of the payment in three, five, seven or 10 years when the ARM is done. We try to focus on cash flow and what will happen to your income over a certain period of time and the traditional arguments you make for and against an ARM," said Sean Sullivan, vice president of Princeton Capital in Los Gatos.

Lately, interest rates have been on the rise, and chances are even more buyers are using them in Silicon Valley, because home prices also have been rising.

When 68.1 percent of home buyers were using ARMs, the median price for all homes (single-family detached, condos and townhomes) in Silicon Valley was $487,000. In May, the Silicon Valley median was up almost 13 percent to $549,000, according to DataQuick.

Once interest rates begin to ratchet up, so does the monthly cost of ARMs. The larger the balance, as in high-cost regions like Silicon Valley, the greater the financial impact.

If the homeowner can't afford the new amount or can't refinance to a fixed rate or other ARM with a manageable monthly payment, the household could lose the home.

"Hindsight is 20-20," says Sullivan.

Real estate writer Broderick Perkins, executive editor of San Jose-based DeadlineNews.Com, writes regularly for this newspaper.