Shopping for a Mortgage?
DO YOUR HOMEWORK FIRST
Specialty Mortgages: What are the Risks and Advantages?
UNDERSTANDING SPECIALTY MORTGAGES
In many housing markets, home prices have risen to very high
levels, making it harder to afford a home-especially for
first-time homebuyers. The traditional fixed-rate mortgage and
standard adjustable-rate mortgage may not be the best options
for everyone. A growing number of homebuyers are deciding to use
one of several new types of specialty mortgages that let them
"stretch" their income so they can qualify for a larger loan.
But before you choose one of these mortgages, make sure you
understand their risks and how they work.
Specialty mortgages often begin with a low introductory interest
rate or payment plan-a "teaser"-but the monthly mortgage
payments are likely to increase a lot in the future. Some are
"low documentation" mortgages that come with easier standards
for qualifying, but also higher interest rates or higher fees.
Some lenders will lend you 100% or more of the home's value, but
these mortgages also present a big financial risk if the value
of the house goes down.
It's in your best interest to learn the "ins and outs" of these
packages before deciding if the loan you're considering is right
for you.
Specialty Mortgages Can-
- Pose a greater risk that you won't be able to afford the
mortgage payment in the future, compared to fixed rate mortgages
and traditional adjustable rate mortgages.
- Have monthly payments that can increase by as much
as 50% or more when the introductory period ends.
- Cause your loan balance (the amount you still owe) to get
larger each month instead of smaller.
COMMON TYPES OF SPECIALTY MORTGAGES
Today, when you apply for a loan, you have more choices than
ever before. Here are a few examples:
Interest-Only Mortgages: Your monthly mortgage
payment only covers the interest you owe on the loan for the
first 5 to 10 years of the loan, and you pay nothing to reduce
the total amount you borrowed (this is called the "principal").
After the interest-only period, you start paying higher monthly
payments that cover both the interest and principal that must be
repaid over the remaining term of the loan.
Negative Amortization Mortgages: Your monthly
payment is less than the amount of interest you owe on the loan.
The unpaid interest gets added to the loan's principal amount,
causing the total amount you owe to increase each month instead
of getting smaller.
Option Payment ARM Mortgages: You have the
option to make different types of monthly payments with this
mortgage. For example, you may make-
- A minimum payment that is less than the amount needed to
cover the interest and increases the total amount of your loan,
- An interest-only payment, or
- Payments calculated to pay off the loan over either 30 years
or 15 years.
40-Year Mortgages: You pay off your loan over
40 years, instead of the usual 30 years. While this reduces your
monthly payment and helps you qualify to buy a home, you pay off
the balance of your loan much more slowly and pay much more
interest.
This is only a short list of specialty mortgages. Today's
marketplace includes many variations on these types.
WHAT ARE THE MAJOR RISKS OF SPECIALTY MORTGAGES?
1. Payment Shock. One major risk is that
your monthly payment may increase by a large
amount, resulting in "payment shock." Even a change of
1% or 2% in interest rates can result in a very big jump in your
monthly mortgage payment. For example, if the interest rate on
your mortgage changes from 4% to 6%, your monthly payment could
rise by as much as 50% (from $1,000 to $1,500). If your income
has not increased enough, you may not be able to afford the new
larger monthly mortgage payment. And if that happens, you could
lose your home.
Example: How Payment Shock Can Occur
Assume you buy a home for $300,000, put 10% down, and choose a
5.75% interest-only adjustable rate mortgage. The mortgage requires
interest-only payments for 5 years. After that, the interest
adjusts every year based on rates in effect at that point.
- Initial monthly payment: $1,294.
- Monthly payment after 5 years with no
increase in mortgage interest rates (amount increases because
payments begin to include principal in addition to interest):
$1,699.
- Monthly payment after 5 years with a 3% increase in interest
rate to 8.75%: $2,220.
2. Higher Debt Over Time. Another risk that
comes with specialty mortgages involves your "equity"-the amount
your house is worth after you subtract the amount you still owe
to the lender. Consumers who choose some types of specialty
mortgages will build equity in their home much more slowly than
with traditional loans. In fact, with some specialty mortgages,
the amount you owe on your home could increase rather
than decrease over time.
WHO IS BEST SUITED FOR A SPECIALTY MORTGAGE?
Specialty mortgages are designed for homebuyers in special
circumstances. The lower initial monthly payments may make sense
for buyers who intend to own a home for a short time or who can
handle high payments in the future. If you are a homebuyer who
plans to be in your home for years, or who does not expect a
significant increase in income by the time the monthly payments
go up, you should very carefully consider the risks and
advantages of a specialty mortgage.
QUESTIONS TO CONSIDER BEFORE CHOOSING A SPECIALTY MORTGAGE
- How much can my monthly payments increase and how soon can
these increases happen?
- Do I expect my income to increase or do I expect to move
before my payments go up?
- Will I be able to afford the mortgage when the payments
increase?
- Am I paying down my loan balance each month, or is it
staying the same or even increasing?
- Will I have to pay a penalty if I refinance my mortgage or
sell my house?
- What is my goal in buying this property? Am I considering a
riskier mortgage to buy a more expensive house than I can
realistically afford?
Be sure you work with a REALTOR® and lender who are willing to discuss different options and address your questions and concerns!
HELPFUL STEPS TO TAKE BEFORE FINANCING A HOME
-
Check your credit status. As of September
2005 (or earlier, depending on where you live), you have the
right to receive a free credit report once a year from each
of the 3 major credit bureaus- Equifax, Experian and
TransUnion. For completeness, it is best to review reports
from each one of them. Contact information is included under
"Additional Resources."
-
Work with your REALTOR® and lender to determine how much you
can afford to pay for a home.
-
Ask your lender for your credit score. This
score, which is calculated based on your credit history and
other factors, determines how lenders view your
creditworthiness and determine the loan terms to offer.
Scoring rules vary widely, but generally a score of 650 or
higher means that you qualify for the most favorable loan
terms.
-
Shop around. Different lenders charge
different rates and fees and have different options. Be sure
to compare to get the best deal. Your REALTOR® can recommend reliable
lenders.
-
Be sure you understand the risks of your mortgage and
know whether you can handle possible payment increases.
The Center for Responsible Lending:
For information about predatory mortgage lending practices,
including "The Seven Signs of Predatory Lending," go to www.responsiblelending.org.
Fannie Mae:
Look for the section "For Home Buyers & Homeowners" at www.FannieMae.com.
Freddie Mac:
Look for the section on "Buying and Owning a Home" at www.FreddieMac.com.
Ginnie Mae:
For a simple calculator to help homebuyers estimate how much
they can afford to spend, read "How Much Home Can You Afford?"
at www.GinnieMae.gov.
HUD Housing Counselors:
For a list of counseling agencies, by state, approved by the
Department of Housing and Urban Development (HUD), go to
www.hud.gov/offices/hsg/sfh/hcc/hccprof14.cfm.
"Looking for the Best Mortgage" is a brochure
on how to shop, compare, and negotiate the best deal on a home
loan. The brochure is a joint effort of 11 federal agencies,
including the Federal Trade Commission (FTC), the Federal
Reserve Board, HUD, and the Department of Justice.
www.federalreserve.gov/pubs/mortgage/mortb_1.htm
National Credit-Reporting Agencies:
Go to www.annualcreditreport.com
to ask for a free copy of your credit report, once a year, or
call 877.322.8228. See, also, www.FTC.gov.
- INTEREST-ONLY MORTGAGES
- NEGATIVE AMORTIZATION MORTGAGES
- PAYMENT OPTION ARM MORTGAGES
- 40-YEAR MORTGAGES
The National Association of
REALTORS®,
"The Voice for Real Estate," is America's largest trade
association, representing more than 1 million members involved
in all aspects of the residential and commercial real estate
industries. For more information, please visit www.REALTORS.org.
The Center for Responsible Lending is a
nonprofit, nonpartisan research and policy organization
dedicated to protecting homeownership and family wealth by
working to eliminate abusive financial practices. CRL is
affiliated with Self-Help, one of the nation's largest community
development financial institutions. Please visit our website at
www.ResponsibleLending.org.
National Association of REALTORS®
500 New Jersey Avenue, NW
Washington, DC 20001
Center for Responsible Lending
910 17th Street NW, Suite 500
Washington, DC 20006
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