Traditional mortgages used to come in one or two flavors; in the past when you purchased a home most people used a fixed rate 30 year mortgage. In today’s market approximately 33 percent of all mortgages come as non-traditional mortgages described by some as “creative and risky” financing. This new breed of mortgage loans allows many to purchase more home than they can actually afford.
Adjustable rate mortgages (ARM) have been around for a while now. These loans offer a low fixed interest rate for an introductory period, after which the interest rate changes based on prevailing short term rates. A new breed of mortgages followed; interest only adjustable rate mortgages allow danger-loving homeowners to make interest only payments during the mortgage’s introductory period.
Adjustable rate mortgages have further evolved into what are called option adjustable rate mortgages. These “option” mortgage loans allow homeowners to pay some or none of the interest during the introductory period. The interest not paid is tacked onto the principal loan amount. This has led to the rise of a new phenomenon called “negative amortization.”
In some circumstances these new loans make sense. For people who earn a living based on commission and have trouble verifying their income, interest only mortgage loans are a godsend. These loans keep the payments low and more cash in your pocket. These loans are good only for the financially responsible; for everyone else they are a disaster waiting to happen.
The risk involved comes when interest rates spike and the introductory period comes to end. Many homeowners are greeted by a dramatically larger monthly mortgage payment and have to struggle to make ends meet. This shock can come in the form of a several hundred dollar increase in monthly payment amount, even a thousand in some cases.
What can you do if this happens to you? Refinance quickly, if you can qualify. To learn more sign up for our free guide, “Five Things You Need to Know Before Refinancing a Mortgage.“
My name is Rob Regehr and I’m a personal finance writer with a chip on my shoulder for banks and brokers that take advantage of my friends and neighbors.
