Housing crunch: with subprime borrowers and homeowners who signed adjustable-rate mortgages defaulting on their loans, lenders and prospective buyers are feeling the pain too.

First-time home buyers Frances Reed and Jessica Morris qualified for a program that let them put no money down on their two-bedroom "dream house" in Washington, D.C., but it required the couple to take out two loans: one of $160,000 at a fixed-interest rate, the second a $40,000 adjustable-rate mortgage. One year later the rate on the latter has risen--and if it goes higher, Reed and Morris may not be able to afford their monthly payment. "We've been really nervous," Reed says. "We sometimes second-guess what we did because of all of the concerns that are out there."

At least they haven't defaulted and their home foreclosed upon, unlike the 168,829 homes that were in the first quarter of 2007, according to Foreclosures.com, up from 83,154 during the same period in 2006. The reason? Rising rates on adjustable-rate mortgages have made monthly payments unaffordable, and a glut of risky borrowers with general financial problems managed to qualify for subprime mortgages.

Last year, lenders extended $600 billion in subprime loans, which allow for home purchases by people who wouldn't qualify for mortgages under more stringent traditional criteria. But now those homeowners are defaulting, wreaking havoc in the subprime lending world. At least 20 companies specializing in the market have quit or sold their businesses in recent months, including industry giant New Century Financial, which filed for bankruptcy on April 2.

"When people took out their loans, they heard what they wanted to hear," says out lesbian Ellen Davis, vice president of the Maryland-based mortgage brokerage firm Mortgage Link Inc. "But if something sounds too good to be true, guess what? It is."

In the past year Davis has worked with a number of buyers who took out loans they could initially afford, like Reed and Morris (with whom she worked), but whose ability to pay off their loans decreased as their interest rate increased. Several clients had little choice but to default, resulting in foreclosure.

It's not just homeowners who are affected--getting a mortgage and locking down an interest rate has become increasingly difficult for prospective buyers. Partners Ken Brown and Jon-Paul Rippetoe moved 15 months ago from Virginia to Maryland, where they're having a house built. In August they'll move in, but they haven't nailed down a mortgage rate with their lender yet. The pair wanted an interest-only loan as part of their financing but are no longer sure about that.

"They [the lender] want us to wait until we figure out the amenities we' re going to add, the different options we'll go for, and what the final price of the home will be," Brown says. But "if the payment is too high, or if they couldn't do the financing that we want, then we'd have to regroup and decide if it's something we can still do."

In mid March, Brown and Rippetoe asked their lender, George Mason Mortgage, if current events will put their loan in jeopardy. "We're ... reviewing all of the guideline changes that our investors have just instituted," the company replied via email. "We'll certainly still be able to provide you with financing. [We're] just not sure if the structure will be exactly the same."

That's essentially what Davis is telling her clients too. "The housing and real estate mortgage industry is there to help people buy and live in homes--live the American dream," she says. "The industry itself is not going to get to the point where people can't get in a home. People will just have to do a better job of protecting themselves in order to do it." Her advice in a nutshell? "Make sure that no matter what type of loan you structure, you can afford it throughout the life of the loan."

Brown and Rippetoe are doing just that, even if it means they might not be able to buy their home after all. "The home we're buying is a stretch goal for us right now," says Brown. "We can handle it if we tighten our belts, but if the rates go up, there's only so much we can do." How confident are they that they'll end up with the home? "I'd say we're 60-40 right now."