Specialty Mortgages: Risks and Rewards
In high-priced housing markets, it can be difficult to afford a home.
That’s why a growing number of home buyers are forgoing traditional
fixed-rate mortgages and standard adjustable-rate mortgages and instead
opting for a specialty mortgage that lets them “stretch” their income so
they can qualify for a larger loan.
But before you choose one of these mortgages, make sure you understand
the risks and how they work.
Specialty mortgages often begin with a low introductory interest rate or
payment plan — a “teaser”— but the monthly mortgage payments are likely
to increase a lot in the future. Some are “low documentation” mortgages
that come with easier standards for qualifying, but also higher interest
rates or higher fees. Some lenders will loan you 100 percent or more of
the home’s value, but these mortgages can present a big financial risk
if the value of the house drops.
Specialty Mortgages Can:
• Pose a greater risk that you won’t be able to afford the mortgage
payment in the future, compared to fixed rate mortgages and traditional
adjustable rate mortgages.
• Have monthly payments that increase by as much as 50 percent or more
when the introductory period ends.
• Cause your loan balance (the amount you still owe) to get larger each
month instead of smaller.
Common Types of Specialty Mortgages:
• Interest-Only Mortgages: Your monthly mortgage payment only covers the
interest you owe on the loan for the first 5 to 10 years of the loan,
and you pay nothing to reduce the total amount you borrowed (this is
called the “principal”). After the interest-only period, you start
paying higher monthly payments that cover both the interest and
principal that must be repaid over the remaining term of the loan.
• Negative Amortization Mortgages: Your monthly payment is less than the
amount of interest you owe on the loan. The unpaid interest gets added
to the loan’s principal amount, causing the total amount you owe to
increase each month instead of getting smaller.
• Option Payment ARM Mortgages: You have the option to make different
types of monthly payments with this mortgage. For example, you may make
a minimum payment that is less than the amount needed to cover the
interest and increases the total amount of your loan; an interest-only
payment, or payments calculated to pay off the loan over either 30 years
or 15 years.
• 40-Year Mortgages: You pay off your loan over 40 years, instead of the
usual 30 years. While this reduces your monthly payment and helps you
qualify to buy a home, you pay off the balance of your loan much more
slowly and end up paying much more interest.
Questions to Consider Before Choosing a Specialty Mortgage:
• How much can my monthly payments increase and how soon can these
increases happen?
• Do I expect my income to increase or do I expect to move before my
payments go up?
• Will I be able to afford the mortgage when the payments increase?
• Am I paying down my loan balance each month, or is it staying the same
or even increasing?
• Will I have to pay a penalty if I refinance my mortgage or sell my
house?
• What is my goal in buying this property? Am I considering a riskier
mortgage to buy a more expensive house than I can realistically afford?
Be sure you work with a REALTOR® and lender who can discuss different
options and address your questions and concerns!
