So, you're looking for a mortgage and you've done your research. You know all about the pros and cons of the basic mortgage types - fixed rate, adjustable rate, VA loans and so on, but nothing seems to be right for you. Don't worry, help is at hand - here, I reveal both the benefits and drawbacks of some of the lesser-known types of mortgages, which although not right for everyone, may be the right option for you.
1. Balloon Mortgages
A balloon mortgage is a short-term home loan which greatly resembles a 'traditional', fixed rate mortgage. The difference is that the mortgage is not paid off at the end of its term because the interest is paid off first, meaning that after a certain amount of time, the whole principal balance is left to pay - usually very quickly. Balloon mortgages can be set up with the option of early repayment, or else over a longer, more typical period such as 30 years.
Generally, balloon mortgages result in paying lower monthly amounts and less interest overall. This type of mortgage also typically allows people to qualify for larger loans than they would be able to get with an adjustable or fixed rate mortgage. Individuals who are cash-poor at the beginning of the mortgage but expecting a large amount of capital before the term ends would obviously benefit from a balloon mortgage - as would people planning to sell their property during the life of the loan.
Balloon mortgages carry a strong risk due to the fact that most of the principal balance is required in one go at the end of a specified term. If the homeowner cannot afford to pay this in one lump sum or as agreed, they must attempt to refinance, which may lead to a mortgage with unaffordable terms.
Could it be right for you?
Whilst not right for everyone, those expecting a large cash sum (enough to cover the principal balance of their mortgage) will benefit from the low interest rates a balloon mortgage can offer. Those planning on selling their property can also definitely benefit from a short-term balloon mortgage agreement.
2. Interest Only (I/O) Mortgages
These are adjustable rate or fixed rate loans which are similar to balloon mortgages in their first term – individuals can choose to only pay off only the interest of their loan during this time, usually ten years. After this, homeowners have the choice of either paying the full principal balance or converting the mortgage into a principal and interest payment system.
Interest-only mortgages mean that the payments during the initial term are very low, making this a good option for people who are cash-poor at the beginning of the agreement and are expecting a large capital income later on.
Because interest-only mortgages represent a higher risk for lenders, interest rates can also be slightly higher. This type of mortgage also means that a homeowner does not build any equity, (the only equity they have is their initial downpayment), and those with an adjustable rate mortgage could therefore be affected negatively by market conditions at the time they would like to sell the house or refinance.
Could it be right for you?
Although there are a lot of high risks to consider with interest only loans, they can be a good option for people who want initial lower repayments so that they can renovate and remodel their property. This would make sense if the work significantly increases the property's value, allowing owners to benefit from selling or refinancing in the future. People who know that they want to move before the interest-only payments end can also benefit from this type of mortgage - as can people who want to liberate monthly cash to use towards retirement funds, or other investments.
3. Reverse Mortgage
There has been a lot of debate over reverse mortgages. An option for older people who have paid off their initial mortgage agreement, these allow individuals to borrow money against the value of their own home. No repayment of the mortgage (both principal and interest) is necessary until the homeowner dies, moves out, or sells the home. After the initial repayment has been accounted for, the amount of interest owed may be as much as the property's original worth – but if it is more than this, the excess does not have to be paid.
Homeowners can access credit either through a large lump sum, regular cash payments or as a line of credit, and credit rating does not matter because the individual's home is used as collateral.
There have been a lot of reported cases of aggressive lending practices and false advertising promises due to the older, more vulnerable nature of individuals this mortgage is aimed at. To avoid this, make sure that the loan is federally insured. Prepayment of the loan (before it is due) can also result in penalties with some reverse mortgage providers. To qualify for this loan, individuals must be at least 62 years of age and live in the residence they wish to mortgage.
Could it be right for you?
Despite reverse mortgages receiving a largely negative reputation, some seniors can benefit from the extra cash a reverse mortgage can provide. Reverse mortgages which are FHA/HUD approved require individuals to take an approved counseling course to ensure that they are eligible for the agreement (and that it is appropriate and manageable for them). By carefully reading all terms and conditions, individuals can protect themselves against false promises.