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Risky Mortgage Terms a Thing of the Past? Not Exactly

[Jul 13, 2009.]


In her Washington Post column, writer Elizabeth Razzi laments the return (if it ever went away) of the balloon mortgage. This is a potentially risky type of mortgage offering payments amortized over 30 years, but the loan is due and payable within a much shorter time, typically five to seven years. This structure requires refinancing or paying off the balloon mortgage by other means. This discussion of balloon mortgages brings to mind several risky mortgage terms that homebuyers and homeowners need to look out for:

  • Prepayment penalty: If a mortgage is paid off before the date specified in the mortgage documents, a penalty fee is assessed. The penalty is typically a percentage of the mortgage balance.

  • No caps on interest rates:  Borrowers considering adjustable rate mortgage loans (ARMs) should be wary of mortgage loans that don't include caps (or limits) on potential interest rate adjustments. Many borrowers who lost their homes due to rapidly escalating payments caused by substantial rate hikes.

  • Bi-weekly payments: Making a mortgage payment every two weeks requires additional financial management and one extra mortgage payment per year. Borrowers can gain the benefit of paying less interest over the term of their mortgage, but no one wants to find out they've committed to bi-weekly payments when they were expecting monthly mortgage payments.

  • Interest only payments: Interest only payments slightly reduce the monthly payment amount in the first years of a mortgage term, but they do not reduce the mortgage balance. This can impede the accumulation of home equity, and can be risky; if home values fall soon after buying, borrowers with little equity may end up owing more on their mortgages than their homes are worth.

  • Negative amortization: This feature is typically associated with ARM mortgage loans offering an initial rate far below current market rates. During the period of low payments, the unpaid interest is added to the mortgage balance. The mortgage balance increases until the interest rate resets with the result being fully amortized payments on a higher mortgage balance.

Anyone planning to buy a home or refinance should carefully shop several mortgage lenders and get multiple mortgage quotes. Read the "fine print" carefully. Asking questions (and more questions) can help prevent unpleasant surprises after a mortgage loan is completed. If a mortgage broker or mortgage lenders can't or won't answer  questions, look elsewhere for a home loan. Those buying a home are advised to shop mortgage loans before looking at homes. This allows time to compare mortgage loans and find the best option without the pressure of finding a mortgage loan after making an offer on a home.


About Author:

Karen Lawson is a freelance writer with extensive experience in mortgage banking and home loan loss mitigation programs. She holds BA and MA degrees in English from the University of Nevada, Reno.

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