Be Aware of Risks Associated with Popular LoansThere are several popular loans in the mortgage business that have caused increasing problems for home buyers.
While these loan programs are not dangerous by themselves, they are structured in such a way that there is little breathing room if even a small disaster strikes, or hardship falls.
While there are many creative loan types available the main three are; payment-option, piggy-back and interest-only.
While you should always consult with a mortgage professional, being aware of the basics of how these loans work is important to a sound financial conversation.
These loans can prove dangerous when applicants don’t understand them and time must be taken by the mortgage officer to educate the borrower about how the loan works and the pitfalls the future can bring.
Payment-option mortgages allow borrowers to choose among four payments each month; a minimum payment based on an artificially low start rate and negative amortization (build up of principle); a interest-only payment involving no principle reduction; or traditional amortizing payments based on 15- or 30 year schedules.
Negative amortization can add as much as 15 percent onto a home buyer’s debt in the early years of the loan and lead to monthly payment increases of 100 percent or more after the loan resets to market rates and a fully amortizing payment schedule. The sudden increase in the payment could be far worse - more than 150 percent a month after the reset - if interest rates in the economy rise during the early years of the mortgage. If you should come across income problems or property values flatten, these payments could be come intolerable resulting in default and major losses on a forced sale or foreclosure.
Interest only loans defer principal reductions and can reduce monthly payments for anywhere from three to 10 years. At the end of the interest-only period, the original mortgage balance remains to be paid. After this period of small payments, they can jump dramataically, sometime by 30 percent or more, because the principle debt must be paid during a shortened period.
Piggyback loans allow buyers to combine a standard first mortgage equal to 80 percent of the property value with a home equity credit line or second mortgage equal to 20 percent of the home value. The arrangement is popular because it allows buyers to avoid private mortgage insurance, requires little or no down payment, and often qualifies jumbo loan borrowers to pay lower interest rates on the primary mortgage.
Banks and mortgage companies say that they are already careful about screening customers and educating them about the risks. Your responsibility is to make sure that this happens for you and avoid undue risk. While you can certainly take advantage of payment-option and interest-only loan savings to make other investments, the short term benefit can quickly become overwhelmed by future problems.
Be careful and educate yourself about your credit and your down payment options. You may not need the extra help, but it doesn’t hurt to take it.
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