More on Exotic Mortgages

These are the dangerous but enticing new offerings that you may have heard of. They are the dream of lenders, who get more people into houses and more loans on their books. They are the nightmare of borrowers who get caught in a financial bind and can't use the standard methods to get out of it, like refinancing or making use of equity to pay off debt. These are exotic mortgages.

The most common is the "interest only" mortgage. It does just what it says: it allows you to pay only the interest on your mortgage. However, this means that the principle of the mortgage -- the amount you owe -- never goes down. So, here's the catch: what if the price of your house falls? What if your downpayment was minimal or non-existent? Well, you then could be the proud owner of a loan, with no real estate asset to show for it, because when you sell, you won't be able to pay off that exotic mortgage.

There are lots of other variations on the same "interest only" theme, all more risky than the rest. Take for example the Stress Free Mortgage, a product offered by Great Financial Mortgage in Fullerton, California. According to an article at MSNBC, you could get a $310,000 loan and have payments as low as $995 for the first year. Sound good? Well, read on. The minimum payment rises each year you have this mortgage, so that after 5 years you are paying $1,330 a month. Still, you get 5 years to get ready for that payment, so it's not so bad. Here's the catch: not only have you not paid down the principle of this loan, by the time you have had it for 5 years, you now owe $329,000.

It gets even worse. At the 5 year point, the payment is readjusted again. Because the size of the loan is getting bigger, the new payment will actually be over $2,000 a month! This is more than double what you paid initially per month. It also assumes that interest rates have not risen, which is another gamble. If rates went up as little as 1 percent over the 5 years you've had the mortgage, you could be looking at a payment of almost $2,300 a month.

So, you'll just sell, right?

Maybe. After all, this interest only deal looks good in a market where housing has been going up in price, often by double-digit percentages, for as long as most 20-somethings can remember. However, I'm an old-timer at 46 and I owned property in the late 80's and early 90's. I bought a condominium and it looked like I had lucked out. A good price in a market that was hot, hot, hot! Then, the bottom fell out about a year later and for the next 10 years, I tried to keep the amount that I owed on the property below the falling sale price I could get for the condo.

It took a full 12 years before I could have sold that place for as much as I paid for it. Which brings me back to exotic mortgages -- most of them don't run for 10 years, and even if they did, it might not be enough time for the market where you are to completely rebound. Heck, if the market doesn't kill you, the payments might -- if you've got one of the more exotic types that keeps increasing the amount you owe.

I hate to point to history, but here's something to give you pause: Interest-only loans haven't been this popular since the late 1920s, and we know what the 1930's meant for many. For that matter, these "negative amortization" loans that actually grow the principle haven't seen light since housing boom of the 80's in California.

As you might know, based on either history or age, both times things ended quite badly.

Michael

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