Most homebuyers have options when it comes to choosing a mortgage. But some loans carry more risk than others. Here’s a look at some of the more risky mortgage loans.
What Makes a Mortgage Risky?
Mortgages are riskier when they have terms that make it more difficult for both the lender and borrower to be sure it will be paid off.
Missing monthly payments is the most common way borrowers default on a loan, often because their income has declined or their mortgage type allows for increases in the interest rate or monthly payment that the borrower can’t afford.
Here are seven types of mortgages that carry increased risk.
1. 40-Year Fixed-Rate Mortgages
Borrowers taking out 40-year mortgages with a fixed rate stretch their loan payments over a longer time. That reduces the monthly payment, but 40-year fixed-rate mortgages often come with higher interest rates than their 30-year counterparts. Plus, you’ll be paying interest on the loan for those 10 extra years.
2. Adjustable-Rate Mortgages
3. Balloon Mortgages
Balloon mortgages require borrowers to make a single large payment at a specific point in their loan term, usually the final payment. While the low monthly payments may be attractive to first-time homebuyers, failing to have the funds to make a larger payment that may run tens of thousands of dollars will put you at risk of default.
4. Interest-Only Mortgages
An interest-only mortgage requires the borrower to pay only the interest on the loan each month, which means you’re not paying down the principal. After a set number of years, borrowers start paying down the principal in addition to the interest, which can make the monthly payment increase substantially.
An additional risk is that most interest-only mortgages are ARMs, which means your interest rate can increase.
5. Loans With No Down Payment
Loans backed by the Department of Agriculture and Veterans Affairs require no down payment. That makes it easier to buy a home, but it also means you start out with zero equity. If the value of your home decreases, you could end up owing more than the market value of the house.
6. Reverse Mortgages
Reverse mortgages are for older homeowners seeking sources of income that let them stay in their home in their later years.
With a reverse mortgage, the lender pays money to the homeowner and the balance on the home increases. The loan doesn’t need to be repaid until the borrower no longer lives in the home, and usually is done by selling the home. Reverse mortgages build debt over time, so there’s less equity in the home when it’s sold, leaving the homeowner with less money to live on or to pass on to their heirs.
7. Subprime Mortgages
Subprime mortgages are targeted at homebuyers with poor credit who may struggle to get approved for a conventional mortgage.
With a subprime mortgage, lenders will approve borrowers with poorer credit for a mortgage that usually has a higher interest rate to compensate for the added risk. Subprime mortgages also are often ARMs, which means the interest rate could increase.