The popularity of adjustable-rate mortgages (search) boosted mortgage applications last week, offsetting the effect of rising interest rates and the toll they appear to be taking on refinancing.

The Mortgage Bankers Association's (search) seasonally adjusted index of mortgage applications rose 2.4 percent to 674.3 last week. Applications for ARMs accounted for 36.6 percent of all applications, the highest level since the MBA began compiling the data in 1990.

The surge in interest in ARMs was a big part of the rise in overall applications, considering the MBA's refinancing index dipped 2.0 percent last week to 1,857.2.

ARMs appeal to homebuyers who want low monthly mortgage payments. But they are riskier than fixed-rate loans because their rates can be reset higher before maturity.

The Federal Reserve (search) has raised official U.S. rates by 1.75 percentage points since last June from a 35-year low of 1.00 percent. The market is betting that the Fed would hike rates another 1.25 percentage points by year-end to curb inflation.

Average rates on 30-year loans climbed to 6.08 percent last week, the highest levels since June 2004, while rates on one-year ARMs spiked up to 4.39 percent, their highest since June 2002, according to Washington-based industry group.

"Payments will go up over time. The cost of ARMs will certainly go up in the future," said Frank Nothhaft, chief economist at Freddie Mac .

ARMs rates have stayed historically low, analysts say, and helped Americans to buy homes in costly areas like the East and West Coasts.

The average price on an existing home in California is close to $500,000, two-and-a-half times above the national average, according to the California Association of Realtors.

About three-quarters of the new loans issued in California are ARMs, analysts said.

Cheap borrowing costs, despite their recent jump, have helped housing turnovers defy market expectations. February sales of U.S. new homes rose 9.4 percent and sales of existing homes dipped a slim 0.4 percent.

The Mortgage Bankers Association's index of mortgage applications for home purchases rose 5.5 percent to 470.9 last week, after it lost 3.5 percent the previous week.

Economists predict that home sales will fall 2 percent to 7 percent this year from the record 7.8 million units sold in 2004.

Cheap ARMs rates have buttressed the U.S. housing market, but some economists warn about their potential negative impact when a large number of ARMS reset at much higher rates in coming years.

The riskiest ARMs, they caution, are interest-only mortgages, which allow homeowners to make small, fixed monthly payments for specified periods to pay off the loans' interest.

When the specified periods of interest-only payments are over, the monthly payments, depending on the size of the mortgage, could soar, analysts say.

In the worst-case scenario, a homeowner with a "5/1" interest-only hybrid mortgage could see his monthly mortgage payment double after the loan's five years interest-only payment term, Freddie Mac's Nothhaft said.

For such a loan with a $450,000 balance, the monthly payment could jump close to $4,500 from $2,015 once the principal has to be repaid, said Greg McBride, financial analyst at Bankrate.com. The payment increase assumes that the loan carries a 5.35 percent rate and would jump to 10.35 percent in the first year of payment reset.

"That's a recipe for financial disaster for a household," McBride said.