Dangers of Current Mortgages

Owning one's own home is a big part of being a member of the middle class. However, homes are expensive enough that most people cannot buy one outright, and thus must take out a very large loan known as a mortgage in order to purchase one. A mortgage is distinguished from the general run of consumer loans because it involves pledging the house (and its associated land) as collateral. If the purchaser fails to pay the loan as agreed, the bank can foreclose upon the loan and take the house back.

Because of the sheer size of a mortgage, it is generally paid over a far longer period of time than the typical consumer loan. While car loans generally will not be made for more than six years, a 15-year mortgage is considered unusually short. Far more typical is the 30-year mortgage, which generally represents a commitment to make house payments every month for the bulk of a person's working life. However, it is generally considered worth it because a well-maintained home will last a lifetime, giving its owners a secure residence for the rest of their lives which appreciates in value and can be passed down intact to one's heirs (unlike, for instance, a car, which depreciates over time as a result of wear and tear, so that inheriting a paid-off car doesn't provide one with any great asset unless it's a collectible car rather than a ride).

Because of the pressure to get more and more people into homes of their own, people who typically would be considered too high-risk for the traditional 30-year fixed-rate mortgage, the 1990's and the first decade of the 21st century saw the proliferation of a number of alternative financial instruments. However, in order to compensate for the higher degree of risk involved in using them, banks generally charged notably higher interest rates on them. In addition, a number of these alternative financial instruments contain other significant risks for unwary homebuyers, leading to surprises that were a significant contributor to the 2008 housing meltdown and the current ongoing economic difficulties. People who were already stretched to the limit as the result of the extraordinarily high gasoline prices of the summer of 2008 suddenly received letters informing them that their monthly house payments were going to jump significantly, all because of the mortgage they chose five years earlier.

What are some of the kinds of risky mortgages that got people in trouble, and why are they so dangerous?

40-year Fixed Mortgage

This mortgage is said to be the least risky among non-standard mortgages. The biggest difference compared to a standard mortgage is that you get to repay it over 40 years instead of the traditional 30 years. Because you're paying it over a longer period of time, your monthly payment is smaller, which enables you to qualify for more money and buy a larger, fancier house than you could have qualified for otherwise (rather like a six-year car loan will get you more car than the five-year car loan that used to be the industry standard). On the other hand, stretching out your payments over ten more years means that it takes a lot longer to start building equity, and over the life of the loan you'll end up paying much more interest on the same amount of money.

Piggy-Back Mortgage

This kind of mortgage involves taking out two other mortgages. These are the home-equity loan or line credit for 20% of the house's price which is used as the down payment. The other 80% serves as the primary mortgage of the house's price. Because it enables you to avoid having to make your downpayment out of savings, it enables you to become a homeowner much sooner in your working life than was traditionally possible. However, because you have no equity in your house when you start, you are exposed to the possibility that the value of your home could decline, leaving you owing more than the home is worth. If you can't make your mortgage payments or you need to move, you could be left still owing the bank money after your house is sold.

Low-Doc Mortgage

It is one of the two second most risky mortgages. In this kind of mortgage, you do not have to provide documentation of your ability to repay the loan. You may not have to even provide proof of your income because they do not ask for financial information. This kind of mortgage was often used by self-employed people and owners of small businesses because their income did not come from wages or salary paid by an employer, and thus did not fit into the standards used for a traditional mortgage. However, such a mortgage should only be undertaken by someone who has done their homework very carefully and knows how much they can afford to borrow. Because nobody at the lending institution is reality checking your ability to repay the loan, you can easily borrow far more than you can ever repay and end up saddled with monthly payments that leave nothing for the other essentials of life.

Interest Only Mortgage

In this kind of mortgage, you pay only the interest on the loan for a set period of years, at which time you start paying on the principal of the loan as well. Many investors used these kinds of loans for various kinds of "flip this house" schemes, since they intended to have the house fixed up and sold well before the loan switched to a regular mortgage. However, far too many homeowners used them to buy their primary residences, depending on hopes of future raises or better jobs to enable them to pay the higher monthly payments when the loans went from interest-only to principal-and-interest. When those bigger paychecks failed to materialize, these homebuyers were left in a very bad way.

Option-Payment Mortgage

This is probably the absolute most risky loan option out there, but a lot of wannabe homeowners were using it to get into homes they couldn't really afford right at the end of the housing bubble. You get to decide how much you want to pay toward interest and principal each month. Generally the bank does set a minimum, but it's often far less than the interest accrued in that month. If you pay less than the accrued interest, the rest is added to the principal of the loan, meaning that you have to pay interest on it as well in future months. If you're not careful, you could easily end up owing far more than the home is worth.

Don't get trapped in a mortgage that has the potential to destroy the happy home you're creating for yourself. Know how much you can afford to borrow, and how your house payment will fit into your monthly budget. Know the risks as well as the benefits of the various non-standard mortgage options out there. And do not expect loan officers or real estate agents to make sure you are buying within your means. Far too many of them have their eyes entirely upon the commissions they're earning and thus are far too willing to push you into more home than you can afford.

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