High Risk Mortgages

Mortgages That Can Cause You Problems

Locked to House
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Buying a home is a big decision. It's generally a long-term commitment with serious financial consequences. One of the most important parts of the deal is your loan: getting the wrong loan can haunt you for years.

Home loans are complicated, and they get especially tricky for borrowers (or lenders) who want to get "creative." In most cases, a standard fixed-rate mortgage (15 or 30 year) is the best deal for a borrower, but there are exceptions.

With that in mind, let's review some of the riskiest types of mortgages and what to watch out for.

Option ARM 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 - you choose.

However, you can get in trouble very easily (and wind up owing more than you borrowed). At some point, you'll have to start paying down the loan. Even if you decide to sell the home, you might find that you're underwater (you owe more on the loan than the home is worth).

For more details, see How Option ARMs Work.

Adjustable rate mortgages are variable rate loans - your loan's interest rate can rise or fall over time. This works in your favor if rates go down because your payments (and total interest costs) go down as well. In addition, you sometimes get a lower starting rate because you’re sharing more risk with the lender.

Unfortunately, the rate can also go up and make your monthly payments skyrocket.

Learn more about Adjustable Rate Mortgages.

Negative amortization loans let you pay less than the interest due over a given period of time. In other words, you owe more each month, instead of less - even though you made a payment.

These may be option ARM loans in some cases. The problem with negative amortization is that (just like with option ARM loans) you have to repay them at some point. When it comes time to pay down the balance, you might not be able to afford the minimum payment, and selling will not work in your favor if the house is worth less than you owe.

For more details, see How Negative Amortization Works.

Interest only loans give you the ability to pay less each month because you’re not repaying principal. These loans make expensive houses seem more affordable, and they free up cash flow for other uses. You can set up your own amortization schedule (if you're disciplined). 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.

Learn more about How Interest Only Loans Work.

Always a Bad Idea?

Any of these loans might be appropriate for you. Unfortunately, they have been overused in the past (although lenders are less willing to make these risky loans). Lenders have allowed buyers to get in over their heads and to sign up for something without understanding the risks.

Sometimes buyers do it to themselves because they want to buy more than they can really afford.

If you’re thinking of using one of these loans, make sure you evaluate the risks and benefits. They make the most sense for short-term investors - not people looking for a place to call home.

Again, the safest option is generally a fixed rate mortgage. But steer clear of loan terms longer than 30 years.

Return to the main Get a Mortgage resource page.