Exotic Mortgages: Dead or Alive?

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Remember the days when anyone could get a mortgage with no down payment and a monthly payment that looked more like that of a car loan than a mortgage? Well, things didn’t end well for most borrowers who took advantage of lax lending standards during the real estate boom. The question is, are there any of these so-called exotic loans even available these days? Read on to find out:

Payment Option ARMs

This infamous loan allowed you to pay less each month than the interest portion of your monthly payment.  The rate often started out at 1% for one month and then adjusted to index plus margin. No worries, though, your payment would remain at that 1% rate for a year while you accrued negative amortization. (Negative amortization basically means that your loan balance went up, instead of down as it should with a traditional mortgage.) But with property values skyrocketing back in 2004, negative amortization was the last thing homeowners worried about.

Where is it now?  The payment option ARM took down a few major banks, including Countrywide and Washington Mutual — and it is officially dead.

Interest Only Fixed/ARMs

These loans had a rate fixed rate for three to 10 years, but you didn’t have to pay any principal. Having to pay the interest portion of the mortgage payment only sure helped your debt-to-income ratio when it came to qualification. Many lenders offered up to 100% financing with these babies.

Turns out someone must have been continuing to make payments after these loans adjusted.  They are still alive.  But, of course, the lending standards are much tighter.  Today, you need a 720 credit score and 30% equity to qualify for such a loan.  And, oh yeah, qualification standards are applied using a fully amortized payment.

Who would want one of these loans today?  They actually make sense if you have very good income and assets and you want to keep your money working for you instead of locking it up in your house.

Flexible Payment ARMs

You could pay interest-only, or you could make a fully amortized payment: it’s your choice. These loans had the flexible payment features of the Option ARM, but without all the nasty negative amortization. Flexibility is good, right?

Apparently not. Flexible payment ARMs are dead.

Piggy Back Mortgages

A piggy back was when you closed a first and second loan together to get a higher loan-to-value, or LTV, than you could get with one loan by itself. So if you could afford a down payment of 10%, you would take one loan for 80% and another for 10% of the purchase price. You could even take one 80% loan and one 20%, and put no money down yourself. Back in the day, in fact, the 80/20 was all the rage.  No money down sure convinced a lot of people to buy real estate. For that matter, why buy one house when you could buy two or three, or five? No down payment loans did not work so well when the speculators fell into foreclosure.

Today there are no lenders offering 80/20, but you can still find a few second mortgages to go behind a first.  The most aggressive lenders, however, only go to a 90% LTV.

Who would want one of these loans today?  They work for people who don’t quite have the 20% down payment, but also don’t want to shell out for mortgage insurance. They can result in a lower payment, but you have to run the numbers.

Piggy Backs… Alive.

Sub-Prime ARMs

100% financing for people with horrific credit.  What a great idea! Payments were low for two to three years in hopes that the borrower could straighten out their issues and actually start to earn the income that they stated on their application. Boy, that little experiment did not end well.

Sub-prime ARMs are dead, along with every major sub-prime lender and a number of Wall Street executives that jumped off of tall buildings.  Sub-prime is dead.

Balloon Loans

Everyone loves balloons, right?  Balloons popped on a lot of people back in the day.  A balloon loan basically has a fixed payment rate for, say, five or seven years, but the payment is amortized over 30 years.  Unlike a 5/1 ARM that turns into an adjustable rate, a balloon loan becomes due and payable after the fixed rate period.  That can put you in quite a pickle if you weren’t planning on selling you house and don’t have the equity to refinance.

So where are balloon loans now?  You’d think they would be dead… but lo and behold: they’re alive.  There is at least one major lender still offering this product. The good news is they offer a modification to the current rate at the end of the balloon term. But what if they discontinue offering the product? Who knows.

Who would want this loan?  It might actually make sense if you knew that you’d definitely be selling the property before the end of the term. Or if you had a serious equity cushion where you knew that refinancing would not be a problem. Other than that, borrowers should probably stay clear of balloon loans.

Tony Wahl
A self-professed mortgage geek, Tony Wahl has more than 20 years of experience in the banking, personal finance and mortgage industries. Prior to joining Credit Sesame, Tony worked at JP Mortgage Chase, Mortgage Guaranty Insurance Corporation (MGIC), and Washington Mutual (now Chase), where he was responsible for developing, managing and optimizing large mortgage operations and underwriting team

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