Exotic mortgages were one of the many factors that contributed to the housing boom and subsequent bust in the mid-2000s. Essentially, exotic mortgages exist to allow you to customize your payments to a very specific situation, often allowing you to buy a bigger home than you can truly afford at the time you take out the home loan.
Payments are often low during the initial years of repayment and jump much higher after a specified time period. Exotic mortgages often offer extremely confusing terms, so understanding the documents you sign for your specific situation is essential.
Interest-only mortgages only require payment of interest during the initial years of repayment. However, after the initial period, payments will increase in order to begin the repayment of the principal of the loan.
The change in payment often shocks consumers. Those who cannot make these increased payments must sell the house to pay off the amount owed or, if they owe more than the value of the home, go through a short sale or foreclosure if they cannot refinance.
In general, interest-only home loans can be taken out with either fixed-rate or variable-rate interest. With variable-rate interest-only mortgages, payments can increase as interest rates rise, which could result in an even higher payment than the borrower initially expected, even during the interest-only payback period.
Payment Option Adjustable-Rate Mortgages (ARMs)
Payment option ARMs uniquely allow you to make one of four different payment options every month. You can either pay the regular payment amount which covers interest and principal according to a fully-amortizing thirty-year loan schedule, a payment that consists of only the amount of interest due, a minimum payment as defined by the loan documents that could cover less than the interest due, or a payment that follows a fifteen-year amortization schedule.
These loans may work well for those with a highly variable income based on commissions and bonuses, but they should not be considered by ordinary borrowers. Instead, these loans often work best for those with high incomes, such as business executives who can afford the risk they would be taking.
Balloon mortgages come in many varieties but all end in the same way. Over the first few years of the loan, your payments may take the shape of an interest-only home loan, an adjustable rate mortgage, or a fully amortizing thirty-year fixed loan. However, when the mortgage ends after the set term, you will owe the full remaining balance on the loan in one lump sum.
Borrowers are often left with a huge balloon payment at the end of the loan since many of these balloon mortgage options pay down very little principal in the initial years. If the borrower cannot repay the amount due, they will have to refinance their home in order to make the payment.
How Popular Are Exotic Mortgages?
Do not expect to find many exotic mortgages available today. While they do still exist, exotic home loans have been phased out by many banks. Instead, banks have leaned more toward qualified mortgages, as defined by the Consumer Financial Protection Bureau (CFPB), which banks can resell to other entities to reduce their financial risk on your loan.
If you think one of the above loans would fit your particular situation, talk directly with the loan officers at your local banks and credit unions to see if they can find a mortgage product that fits your needs. In general, local-run banks will have more options available than larger banks that often must follow strict corporate policies.