Risky Home Mortgages

Mortgages with risky terms or ones based on dicey credit standards are mortgages that can cause you problems.  High risks mortgages may have an appropriate use in the mortgage marketplace for those borrowers who do not meet conforming guidelines.  Borrowers who exhibit the needs of a high risk loan commonly needed a mortgage loan due to slow credit, extremely high loan amounts relative the homes value, or loans to speculate on real estate.  In an earlier period, high risk loans were introduced to serve just this market segment.  High risk loans were designed to relax the requirements for credit standards, little to no down payments and excessive debt ratios.  Sub prime loans are the typical loan type we think of regarding high risk lending.  As of recent, these loans have morphed and have now been used for a variety of purposes and sold to borrowers who don’t fall into a category of needing a home loan used for high risk transactions.

A mortgage is a loan that provides you with the resources to buy a home.  If you aren’t educated about the types of loans that are available, some lenders may attempt to sell you a mortgage with lots of features and variations that don’t apply to your particular needs.  There are many different products out there and some of them are dangerous.  Make sure you know about high risk mortgages that can potentially get you in trouble.  With slightly higher rates or conditions that are pushed onto the borrower, many lenders find offering these products more attractive for their overall rate of return.

Option ARM (adjustable rate mortgage) loans are probably the most dangerous type of mortgage.  These loans give you a lot of flexibility when your monthly payment is due: pay a little or pay a lot.  However, you can get in trouble very easily.  Option ARM loans are mortgages that give a borrower a choice on how much a given payment is.  This seems like a valuable feature inasmuch as you have the flexibility to respond to month to month circumstances.  You can make a minimum payment, a full payment, or an interest only payment.  These loans are filled with pitfalls.

First, you don’t build equity unless you make the full payments that you would make with a conventional mortgage.  Given a choice between a large payment and a small payment, which one will you choose?  With the smaller payments, you’ll actually owe more on your house at the end of the month than you did at the beginning, a situation of negative amortization.

Another peril of an Option ARM is that small payments will not last forever.  Sooner or later the bank will want to put you back on schedule to pay the loan off, and will “recast” your loan at given intervals, or when you owe too much on the home (110% or 120%, for example) due to negative amortization.  When they recast, they set the loan on track to fully amortize over its remaining life, and your minimum payment can increase sharply.  If your budget can’t afford this increase, you’re in trouble.

An option ARM is almost always a bad idea.  The mortgage rates on option ARM’s are initially a very low teaser mortgage rate.  As soon as the introductory rate period or teaser rate is over the fully adjusted rate on this loan is as high as a 30 year fixed rate loan.  Sometimes, the fully adjusted rate is distinctly higher than a 30 year fixed rate.  If the introductory rate lasted a reasonable length of time, the low initial rate may have some value.  The problem with the option ARM is that this teaser rate expires anywhere from one month to six months.   The option ARM is clearly one of the worst loan products that were sold on a wide scale and in the category of Arms has the least favorable terms.

Interest only loans give you the ability to pay less each month because you’re not repaying principal.  You can set up your own amortization schedule, that is, a schedule for paying back principal.  However, you can also end up without any equity in your home – and possibly have to write a check if your home loses value and you want to sell it.  Interest only loans should be used by the most disciplined of borrowers.  The interest only option allows for a lower payment but, the principal has to be paid back at sometime.  Delaying the repayment based on estimates of future home appreciation or the ability to refinance at a later date under more favorable terms may be a gamble that can cost you your home.

The home loan programs that have yielded some of the biggest problems this year are the no income verification loans and the various permutations of them.  Alt-A, no income, no doc, and stated income are all terms to describe similar loan programs.  These loan types don’t require the borrower to document their income.  For the self-employed borrower who would employ aggressive techniques for write offs against their revenue stream or income, these loans filled a need.  Recently, the use of low document income loans or no document income loans were used for wage earners and borrowers who had income that would have been easily verified.  These mortgage loans may allow a borrower to qualify for a loan that under normal underwriting guidelines would have been impossible.  The risk and cost for the borrower is now trying to figure out how to make the monthly payment on a loan based on income that they did not actually earn.  Foreclosure figures on this loan type are certainly proving that not verifying income is not a free ride to homeownership.

Many of these loans have in fact opened the door for increased number of borrowers to become homeowners.  Some of these home loan products may be appropriate for you.  If you’re thinking of using one of these loans make sure you understand the risks.  Don’t be tempted by the reassurances of a mortgage lender that profits at your risk.  It may make more sense to buy a less expensive house with a fixed rate mortgage or repair your damaged credit first.  Do your research and comparison shop before making the leap.