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Beware of these home loans
These days, it can be easy to get a mortgage even for a home that seems financially out of reach. And homeowners can tap home-equity loans to finance everything from a Lexus to a trip to Las Vegas. But this is not such a good thing. Many loans that mortgage brokers and lenders are pushing increase the odds of foreclosure by allowing borrowers to accept more risk than they can manage, especially if home prices level off or if interest rates increase. That’s because some loans, such as interest-only mortgages, keep monthly payments artificially low at first but can skyrocket to unaffordable levels later on. Widespread defaults haven’t occurred because the loans are relatively new, home prices have continued to rise, and interest rates have remained relatively low. But regulators are paying close attention to the rapid growth of nontraditional mortgages, which in states like California and Nevada made up more than half of new mortgages in recent months. In May 2005, banking agencies issued guidelines to rein in the use of some unconventional home-equity loans and may soon do the same for first mortgages. Here are some of the riskiest mortgages, and why we don’t recommend them: Interest-only mortgages. After 3, 5, or 10 years of paying only interest on your loan, monthly payments can jump 25 percent when principal is added to the bill. Because most of these mortgages have adjustable rates, you could get hit with a double whammy. If after 5 years the rate on your $200,000, 5 3/8 percent mortgage rises by 5 percentage points, for example, your payments, including principal, could double, from $896 to $1,871. With rates rising, it may be hard to find a cheaper loan or to sell. Because you haven’t paid down equity, you can end up owing the bank more than your home is worth if housing prices fall. Option ARMs. These adjustable-rate loans let you make payments that may not cover interest, meaning your mortgage balance could balloon over time. “When the loan balance hits 110 percent or 115 percent of the original loan amount, you might find yourself on the bad end of a gamble,” says Keith Gumbinger, vice president of HSH Associates, a financial publisher in Pompton Plains, N.J. You’ll eventually have to pay down the loan, and payments might be unaffordable. Piggyback loans. If you don’t have enough for a down payment, you can take out a loan that piggybacks your mortgage. But this could swamp you in debt, especially if the loan is adjustable. Many lenders also offer piggyback home-equity lines of credit, or home-equity loans with risky features such as interest-only payments. With both, payments can quickly become unaffordable and you could lose your home. Bottom line. With today’s low interest rates, the best option for most buyers is still a 30-year fixed loan. |
