Nontraditional mortgages: appealing but misunderstood

Nontraditonal mortgages offer potential benefits for home buyers in strong, stable housing markets. Various payment options increase flexibility and enable borrowers to significantly reduce payments in the short term. In rapidly appreciating housing markets, these options also allow borrowers with certain needs, such as those who must live in areas defined by their employers (e.g., police, municipal workers, etc.), to make home purchases where real estate price increases have outpaced their capacity to buy using conventional financing. These mortgages typically feature lower initial monthly payments, or the option to make lower payments for some period, compared with traditional fixed or adjustable rate mortgages. However, these lower payments can increase significantly if the borrower initially makes only the minimum payment, which may comprise less than the interest due. Nontraditional mortgage products can be effective tools for borrowers who are financially sophisticated and understand the risks of payment shock and negative amortization.1 Less financially savvy and less credit-worthy borrowers may not necessarily understand the terms and consequences of these products. In some instances, borrowers have found they owe more than their house is worth, even in appreciating markets, as a result of negative amortization.