Home Loan Choices Can Be Good....or Not

Some home loans are downright dangerous

The mortgage and lending industry has been booming for nearly a decade now. Part of the success is due to the fact that lenders have gotten quite creative in coming up with ever-new home loan products. By inventing a huge variety of home loans, the lenders now have something for everybody and they do their best to make sure that just about anyone can buy a home.

And while the variety of lending products is greater than ever and while home ownership is at its highest level ever, we would be remiss if we failed to point out that some types of loans should be used judiciously, if at all. Some types of loans are poor choices, and they are poor choices for just about everyone. 

Here is a short summary of some of these types of loans and why they should generally be avoided.

Interest-only Adjustable Rate Mortgage - While there is a genuine need in the market for an adjustable rate mortgage, or ARM, the interest-only version is a not so wise variation. An ARM might be a good choice for someone who knows that he or she will only be in a house for two or three years; the rate will probably be competitive for that period of time. The interest-only version, however, adds an unpleasant wrinkle to the process. In this version, the borrower makes monthly payments, but for the first few years of the loan, say five, the monthly payment only covers the interest on the loan. Nothing goes towards the principal of the loan, so after several years of payments, the borrower still owes just as much as he or she did at closing. If the value of the house has fallen in the meantime, then the house will now be worth less than the amount owed on it. That’s a huge problem if the owner needs to sell.

The Option ARM - The evil twin of the interest only mortgage takes the already questionable product a step further. In this case, the borrower is given a several choices each month as to how much he or she wishes to pay. One of those options, and the one most often used by buyers, is the “minimum payment.” The minimum payment is so small that not only does it not contribute to the loan principal, but it doesn’t even cover that month’s interest on the loan! With an option ARM, each time you make the minimum payment, the amount you owe increases. 

The 40 year mortgage - This sounds like a great idea. Lower the payments by spreading them out over a longer period of time. The problem with this one is that while the savings on the monthly payment are small, the amount of extra interest you pay in the extra 120 payments is huge.

Each borrower has his or her own special needs, and there are certainly cases where each of the above loan types might be the best choice for a particular situation. Most of the people who take out such mortgages do so for one reason only, and it’s the wrong reason - to keep payments as low as possible. If you need one of these loans to buy a house, you are either buying a house that’s too expensive or you do not have enough money. Avoid them.