One of the most important things the world learned from the 2008 subprime crisis is to borrow money very carefully if you want to buy or refinance a house. Depending on the type of mortgage you select, you may be able to avoid bankruptcy or foreclosure a few years into the loan term or even become the proud owner of your home one day.
Is it possible to steer clear of the latter? You can definitely do so by selecting a mortgage loan that isn’t too risky for you.
Buying a home is a significant financial decision, and choosing the right mortgage is crucial for ensuring a smooth and successful journey. While there are numerous mortgage options available, some come with inherent risks that can lead to financial hardship This article delves into five such risky mortgage types that you should avoid to safeguard your financial well-being.
Understanding Risky Mortgages:
Before diving into specific loan types, it’s essential to understand what makes a mortgage risky. Essentially, a risky mortgage is one that doesn’t align with your financial capabilities and circumstances. It’s like wearing shoes that are two sizes too small – uncomfortable and potentially harmful in the long run
1. 40-Year Fixed-Rate Mortgages: The Long and Winding Road to Debt:
While fixed-rate mortgages offer stability, opting for a 40-year term can be a financial trap. Although the monthly payments might seem lower, the extended repayment period translates to significantly higher interest payments over the loan’s lifetime. Consider this: a $200,000 loan with a 5% interest rate would result in a staggering $236,617.86 in interest alone over 40 years. That’s a hefty sum that could be better utilized for investments, retirement planning, or other financial goals.
2. Adjustable-Rate Mortgages (ARMs): Riding the Rollercoaster of Interest Rates:
ARMs entice borrowers with lower initial interest rates, but this introductory phase is followed by periodic adjustments based on market fluctuations. This means your monthly payments can rise unexpectedly, putting a strain on your budget. If you have a fixed income or anticipate income instability, ARMs can be a recipe for financial stress.
3. Interest-Only Mortgages: Kicking the Can Down the Road:
Interest-only mortgages offer lower initial payments by deferring principal repayment. While this might seem attractive, it’s crucial to remember that you’ll eventually have to pay back the entire principal amount, often with a hefty lump sum payment. This can lead to financial difficulties down the line, especially if your income hasn’t significantly increased.
4. Interest-Only ARMs: A Double Whammy of Risk:
Combining the risks of both interest-only mortgages and ARMs, this hybrid loan type exposes borrowers to double the uncertainty. Not only do you have to grapple with fluctuating interest rates, but you also face the challenge of a significant principal repayment later on. This loan type is best avoided unless you have exceptional financial foresight and the ability to handle potential financial turbulence.
5. Low Down Payment Loans: A Slippery Slope to Negative Equity:
While putting down a small down payment might seem appealing, it can leave you vulnerable to negative equity, a situation where you owe more on your mortgage than your home’s market value. This can make it difficult to sell or refinance your property, potentially trapping you in a financially precarious position.
The Bottom Line: Choose Wisely, Avoid Risky Mortgages:
Selecting the appropriate mortgage is a crucial choice that will affect your financial situation for years to come. You can avoid financial pitfalls and make wise decisions by being aware of the risks connected to different loan types. Recall that a mortgage should not be a burden that drags you down, but rather a tool that enables you to reach your goals of becoming a homeowner.
Why You Might Not Want an Interest-Only Mortgage
An interest-only mortgage can be extremely risky for one or more of the following reasons:
- If the interest-only period ends, you might not be able to afford the much higher monthly payments. In addition to repaying the principle earlier than you would with a fixed-rate loan, you will still be paying interest.
- If you have little to no equity in your home, you might not be able to refinance.
- If your home’s value drops and you have little to no equity, you might not be able to sell and end up underwater on your mortgage.
- For the duration of the loan, borrowers with interest-only loans pay a lot more interest than they would with a traditional mortgage.
- You might have to make a balloon payment at the end of the loan term, depending on how the loan is set up.
Any of these problems could cause you to lose the home in a worst-case scenario. The loan could end up costing you far more than you actually need to pay to be a homeowner, even if none of these issues arise.
40-Year Fixed-Rate Mortgages
Fixed-rate mortgage holders do not have to worry about unforeseen circumstances, but that does not always make them a wise choice. Thats because you end up paying more in the long run. The longer your borrowing period, the more interest you end up paying.
Heres a hypothetical situation. Lets say you want to buy a $200,000 home with a 10% down payment. The amount youll need to borrow is $180,000 ($200,000 minus $20,000). Here are the monthly payments and the total amount you will pay for the house under various terms if you keep the loan for the duration of the property, at an interest rate of 5%:
| Term | Interest Rate | Monthly Payment | Lifetime Cost (Including Down Payment) | Principal (Including Down Payment) | Total Interest Paid |
| 15 years | 5.0% | $1,423.43 | $276,217.14 | $200,000 | $76,217.14 |
| 20 years | 5.0% | $1,187.92 | $305,100.88 | $200,000 | $105,100.88 |
| 30 years | 5.0% | $966.28 | $367,860.41 | $200,000 | $167,860.41 |
| 40 years | 5.0% | $867.95 | $436,617.86 | $200,000 | $236,617.86 |
So if you dont refinance and keep the loan as is, youll pay $236,617. 86 in interest alone by the end of the 40-year period. This is a simplified comparison. The interest rate will probably be lower for the 15-year loan and the highest for the 40-year loan.
Below is a more realistic comparison using interest rates based on the term of the loan.
| Term | Interest Rate | Monthly Payment | Lifetime Cost (Including Down Payment) | Principal (Including Down Payment) | Total Interest Paid |
| 15 years | 4.5% | $1,376.99 | $267,858.83 | $200,000 | $67,858.83 |
| 20 years | 5.0% | $1,187.92 | $305,100.88 | $200,000 | $105,100.88 |
| 30 years | 5.2% | $988.40 | $375,823.85 | $200,000 | $175,823.85 |
| 40 years | 5.8% | $965.41 | $483,394.67 | $200,000 | $283,394.67 |
As you can see in the second chart, the 40-year mortgage is 0. 6% higher in interest than the 30-year mortgage. That lowers your monthly bill by only $22. 99 a month, from $988. 40 to $965. 41 However, it will cost you a whopping $107,570. 82 more over the life of the loan.
That’s a sizable sum of money that you could use to finance your retirement or your kids’ college education. At best, youre forgoing money that you could have spent on vacations, home improvements, and any other expenditures.
Is Ford Finance taking riskier loans to sell more cars? #carbuying #finance #autofinancesense
FAQ
Which loan is riskier?
What is considered a high risk loan?
What are the riskiest loans called inside job?
What is a risky mortgage?
A risky mortgage is really a loan product that doesn’t correspond to the borrower’s ability to repay it. In 2008, certain mortgage types were being matched with the wrong borrowers, and lenders were reeling them in with the prospect of refinancing soon.
What types of loans are considered high-risk?
Here are some types of loans considered to be high-risk, and why: Bad credit personal loans. When a low credit score makes a conventional loan impossible, some lending institutions will approve a personal loan for use in a financial emergency.
What is a high-risk borrower?
Lenders label a loan applicant as a high-risk borrower when the applicant’s low credit score and/or poor credit history means he or she has a high possibility of defaulting. To a lender, a high-risk borrower likely has few, if any, other options for a loan.
Are certain types of mortgages inherently risky?
Many of us have come to believe that certain types of mortgages are inherently risky mainly because of what happened during the housing crisis. In fact, some of the mortgages available on the market weren’t especially risky for the right consumers.