By Martin Lukac
The use of nontraditional mortgages, such as interest-only and payment-option, has risen along with home prices and the real estate market. Should you take the risk?
The Federal Reserve and other government regulators are concerned that these nontraditional loans may be a little too risky for the average consumer. They feel that too many borrowers are putting a lower monthly payment and more expensive home above the risks associated with these loan programs, such as large jumps in monthly payments. There are many different new loan products to choose from out there.
One of the most popular is the payment-option mortgage. Though this type of mortgage has been around since the 80's, many borrowers had to be in tip-top financial shape to take one out. But now they have become more main stream.
Payment-option mortgages are the most risky type of mortgage. They remind me of a credit card. You get to choose how much you pay each month. You can pay the principal and interest, the interest only or a minimum payment that is less than the interest you owe. The difference in interest is added on to your principal balance. This causes what you owe to actually go up instead of down. You will owe more after a year than you borrowed if you pay only the minimum payment. The risk is that your home may not be appreciating as fast as you are racking up money on your mortgage.
If you have had problems with credit cards, budgeting or making ends meet, this is not the loan program for you. But if you are very very financially disciplined, but need to make a smaller monthly payment once in a while, you could make it work. But these loans are also adjustable in rate, another added risk.
Interest-only mortgages are the second highest risk mortgage. You only pay the interest for the first three to ten years of the loan. Then you will begin to pay both the interest and principal after the interest-only period expires. You have to keep in mind that in a few years, your payment is going to practically double. You have to be able to handle the payment and plan for it.
If you know that in, for example, three years your income will not increase, what would make you be able to afford the payment. The monthly payment on a 30-year interest-only loan after the principal is tacked on will be higher than a traditional 30-year fixed-rate mortgage. This is because you are paying your principal back over a shorter amount of time. Think of it as renting your home from the mortgage company for a few years before you start to pay for it.
This type of loan is best for those who know they will be moving before the interest only period is up. But remember, you aren't building equity when you aren't paying down the balance. If you know that you will be making significantly more money in a few years because your wife is getting her law degree, then the risk may be less for your family.
New Low-doc mortgages are also risky. You take a higher rate in exchange for not having to prove that you qualify for the loan. In some cases, you don't even need to show proof of income. The risk is that you take out more mortgage than you can afford.
Low-doc mortgages might be a good choice for those who are starting their own business or just starting a new job. You should be sure that you will be able to make the payments.
The 40-year fixed-rate mortgage is the least risky of nontraditional mortgages. In some areas of the country, you can even find 50-year fixed-rate mortgages. You have the security of a fixed rate, but the lower monthly payment you may need. The payments will be lower, so you may qualify for a more expensive home.
The downside is that you will be paying a lot more in interest over the years and your equity in the home will build very slowly. You have to make the decision for yourself. A 40-year mortgage could give you the security of a lower monthly payment and a fixed rate, and if there is no prepayment penalty, you could pay it off quicker by making extra payments when times aren't financially tight.
In the end, only you know what works for you and what doesn't. But make sure that you fully understand what will happen with any type of mortgage. You can really only afford these type of mortgages if you can pay them in the worst case scenario, such as the mortgage hitting the highest possible interest rate and having to pay the principal back too.
Martin Lukac, represents Rate Empire, a finance web-company specializing in real estate/mortgage market. We specialize in daily updates, rate predictions, mortgage rates and more. Find low home loan mortgage interest rates from hundreds of mortgage companies! Visit Rate Empire today.
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