SAGE FINANCIAL

UNDERSTANDING RISKS OF CREATIVE LOANS

©Copley News Service

Creative mortgage loans keep the wheels of the housing industry turning by maximizing consumer buying power.  They also allow middle-wage earners to continue buying high-priced homes.

But the trade-off is an increased risk of default.

Some experts say it’s a reversal of decades-old trend of protecting borrowers. Supporters hold that such loans make homeownership possible for people who otherwise would remain priced out of the market.

Adjustable-rate mortgages can’t increase beyond agreed-upon annual caps that generally range between 2 percent and 6 percent.

Unlike traditional fixed-rate loans, such mortgages often are viewed as short-term vehicles for attaining homeownership.  Some borrowers may plan to refinance or sell before low-cost introductory rates adjust upward.  But that requires a higher level of consumer awareness.

Here are several examples of creative loans:

·        N0-documentation or low-documentation – Such products allow people to borrow without fully documenting their income.  Most lenders expect consumers to have a FairIsaaccCorp., or FICO, credit score of at least 680.

RISK:  Critics say this type of loan almost invites consumers to borrow more than they truly can afford.  Depending on their credit score and how much documentation they provide, the rate may be on-half to two points higher than that for a standard loan.

·        Interest-only adjustables – Payments cover only the loan’s interest, not the principal debt, during the first three to 10 years.

RISK:  After the interest-only period ends, payments could increase beyond the borrower’s ability to pay. 

·        Option or flex-payment adjustable – The borrower can decide how much to pay every month, a 30 or 15 year fully amortized payment, just the interest or minimum payments that don’t cover interest.

RISK:  If you lack discipline, you may wind up owing more money than your home is worth.  If you make minimum payments, the rest of that month’s interest is added onto your loan balance.

·        40-year fixed – Borrowers repay the fixed-rate loan over 40 years instead of the standard 15 or 30 years.  This creates smaller monthly payments and increases the size of the loan a borrower may qualify for. 

RISK:  It will take longer to build home equity.  Unless borrowers sell or refinance, they will pay more interest over the life of their loan.

·        Simultaneous second or piggyback loan – Borrowers with little money for down payments can achieve 100% financing by taking out 2 loans.   They also avoid the need to buy private mortgage insurance, which usually is required for people who can come up with a down payment of at least 20 percent.

RISK:  If home prices drop, borrowers could end up owing more than their home is worth.