Exotic Mortgages

These Mortgage "Bargains" Have Serious Risks

Homeowners who took out non-traditional mortgages in the past few years might have enjoyed low payments for a while, but there may be hard times ahead for many, according to some experts and a recent federal report. According to the Federal Deposit Insurance Corp. (FDIC), the housing market is unstable right now, and conditions for some borrowers will be tricky, in part because of exotic mortgages.

What is an Exotic Mortgage?

An exotic mortgage is a mortgage that doesn't follow the traditional pattern of 15 or 30 years, fixed rates. Usually what's different about the exotic mortgages is how interest is calculated, when you begin paying interest, and how much down payment the borrower puts down at closing. The mortgage companies basically play with the numbers where they can, to make a mortgage package look more attractive to potential borrowers who might be short on cash or who have bad credit. The numbers the mortgage companies play with are the interest rates. Why? Because they can't really change any of the other numbers involved in determining your monthly payments. That is, they cannot change the price of your home, and they cannot change market interest rates. What they do is do everything they can to make the monthly payment as low as possible...initially. They will advertise the mortgage via the low monthly payments. You've seen them everywhere: ads that say something like "Borrow $200,000.00 for as low as $1000 a month!". Well, the low payments are only temporary, and once that temporary period of low payments is over, borrowers will feel the crunch. Their payments will skyrocket, and in the long run they end up paying more for their home than they would have if they'd taken out a simple 15 or 30-year fixed-rate mortgage. Well, that's what is happening right now with borrowers who fell for the "low monthly payments" ads, and took out an exotic mortgage. Now that they've had the exotic mortgage a few years, those honeymoon periods are ending and people are feeling financial pain. That's what the new FDIC report is all about.

Interest-Only & Negative Amortization Mortgages

Basically, these are the two types of mortgages that qualify as exotic mortgages. The conditions are non-standard, and combined with an inflated real estate market, help to create a situation of concern on a national level, leading to missed payments and foreclosures. The FDIC report cites the interest-only & negative amortization mortgages as a cause for concern because they account for 55 percent of sub-prime mortgages in the State of Arizona last year (2005). Although the report doesn't cite any firm examples of imminent signs of danger, they are more concerned about further down the road, as the exotic mortgages age and the terms become more difficult for cash-strapped borrowers to meet.

Negative-amortization mortgage loans are particularly dangerous because at the beginning of the loan period, you pay a small monthly payment that doesn't even cover the interest on the loan. The interest that doesn't get covered by your falsely low monthly payment actually gets added to the loan amount that you owe. Therefore, instead of paying down your debt, you're actually increasing your debt! This is crazy, in personal finance planning terms. This can be devestating to your bank account in the long run, since the total amount of money you will end up paying for your home will increase a lot.

The Real Estate Bubble & Exotic Mortgages

Inflated Real Estate Markets Make Exotic Mortgages Even More Dangerous

When the prices in an area are inflated, and keep rising, we call it a bubble, or a real estate bubble. This means that if you buy a home in a real estate bubble, you are buying at inflated values. Bubbles can pop or they can deflate slowly, but either way, even if the decrease in value is a slow deflating action, holders of exotic mortgages are going to suffer financially. These people are going to find themselves in a situation where they realize it's impossible to repay their mortgage loan. If the real estate market slows down, or just stalls, they are left holding a property that's not worth as much as it used to be worth. Plus, they may not have even begun to pay off their loans, if they've taken out an exotic mortgage that pays interest only or has negative amortization for the first few years.

Loan Defaults & Foreclosures

With those ingredients in place, we have a recipe for a real disaster in the personal finance world. People will begin to default on their mortgage loans, then eventually find themselves in foreclosure situations. This could be widespread, based on the high rates of exotic mortgages that have been amassed by borrowers in the past few years.

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