In the wake of the U.S. housing bubble and resulting global financial crisis, mortgage risk was lowered substantially in that it became much harder for aspiring homeowners to get a risky mortgage or to refinance their mortgage into one. But for house-hunters with the credit to back up a mortgage in today’s market, risky loan agreements still loom over the realm of possibilities. Don’t let the countless real estate leads from your agent fool you. A buyer’s market does not mean you will get a buyer’s deal.
Undergoing a scrutinizing approval process can lead borrowers to believe they’ve entered a safer agreement than the ones that have caused countless homes to go into foreclosure. Banks are certainly better at preventing unworthy borrowers from being approved, but that doesn’t mean they’re right, and that doesn’t mean outside forces can’t alter the way a mortgage adjusts over the years.
Here’s a rundown of the riskiest mortgages out there:
This one’s the star of the show when it comes to risky mortgages. It’s become infamous due to its role in the disintegrating U.S. housing economy of the late 2000s. Think of them as the “payday loan” version of mortgages. In exchange for the risks of an unreliable borrower, banks issue out loans with high interest rates and less-than-desirable penalties and other caveats attached. When the housing bubble burst, 80 percent of subprime mortgages were adjustable-rate mortgages. An ARM means that in return for an initial low-interest payment, borrowers agree to let the interest rate balloon over time. Mortgage payments can double, making repayment nearly impossible unless additional income arrives.
This spin-off of the adjustable-rate mortgage, the option ARM loan, gives borrowers the option to either choose between a specified minimum payment, an interest-only payment, or 15 to 30 year fully amortizing payments. Most options lead borrowers into a situation where either minimum payments defer interest and add it back on top of the loan, where interest is re-applied, or where the monthly payment skyrockets. These loans are designed primarily for individuals who anticipate an increasing source of income that haven’t yet amassed the credit history for pricy mortgage borrowing and work best in 15-year stints. Otherwise homebuyers should stay away, because their home can easily start costing them more than it’s worth.
Piggy-back loans involve the borrower taking out a home-equity line of credit, or HELOC, for 20 percent of the home’s value to use the cash advance as a down payment. The remainder is covered by a primary mortgage. This enables the borrower to avoid paying private mortgage insurance and is ideal when an aspiring home owner has enough cash-on-hand for a down payment just shy of eliminating the PMI payment. But because of the lack of equity from the starting gate, a falling housing market can quickly cause your home to lose value and you lose money in the event of a sale.
40-year fixed-rate mortgages were sketchy even before the housing market tanked. The extra decade seems like a relative pittance of time in exchange for lowered payments, but you ultimately pay an extravagant amount more than the true value of your home when you settle for a 40-year loan repayment period. To make matters worse, most people would get into a long-term mortgage without even making a down payment, thus delaying the equity-building period.
The 30-year fixed-rated mortgage is the traditional safe haven for most aspiring home owners. It’s a safe and relatively secure way to take out a mortgage and doesn’t demand an overly-excessive amount of interest to be paid back, especially if the PMI can be avoided with a hefty down payment. However, banks have historically never liked the 30-year fixed-rate mortgage. In fact, post-bubble burst bank lending policy changes have mostly revolved around the goal of reducing the risks of 30-year fixed-rate mortgages as much as possible.
What this means is there’s going to be much higher benchmark for this kind of loan than ever before. While it’s still the safest loan that most borrowers can potentially get, 30-year to 40-year fixed rated mortgages are going to have a lot more caveats and cutthroat standards than ever before.
What to do: Lock In the Mortgage or Pay Off Early
The best thing aspiring home owners can do to make sure they avoid becoming trapped in a never-ending mortgage hike or fall into foreclosure is to get a fixed-rate mortgage on a short repayment schedule. Easier said than done considering the monthly payments on such loans are high and refinancing near impossible so long as prices stay stagnant. But since mortgage rates have nowhere to go but up, considering their artificially low level now, and home ownership should be looked at in terms of decades, it’s definitely smart to stay fixed and succumb to a short-term repayment plan. Otherwise you could be at risk of taking out a risky loan from unforgiving bankers.