In recent years during the housing boom many lenders and mortgage brokers developed and pushed “creative” mortgage programs. These programs were intended to allow people that couldn’t afford a conventional fixed loan the ability to get into a home. The problem came when brokers were not matching the correct program with the correct borrowers and simply pushing or allowing people into homes that were not in the best financial situations. There were also the predatory brokers/lenders that preyed on the elderly, young, and single women that didn’t make things better.
There are a multitude of different creative programs out there. To keep everyone on the same page we are basing our assumption of a “creative” mortgage as one that differs from a 30-year conventional loan.
Balloon Payment Mortgages:
Balloon payments are mortgages that allow the borrower to make small payments with a lower than usually interest rate over a given period of time (usually 5 to 7 years). The catch with a balloon payment is at the end of the stated term the full principal is due. In order to get into this type of mortgage lenders usually want to see some type of assurance that the final payment can be made (but in recent years this practice has fallen by the wayside and homebuyers are getting in over their head). Some lenders though will allow you to refinance at the end of the period at a higher interest rate (check the fine print).
Wrap-around Mortgages:
Wrap-around mortgages work exactly as their title says. You wrap a new mortgage around the existing home loan. These types of loans are most commonly known to be provided through the seller of the home (although they can come from actual lenders). These loans are also geared towards borrowers who might have trouble getting a mortgage through traditional sources. Here’s how these loans work:
Seller is selling a home for $225,000 with $175,000 left in a mortgage (at 5.5% interest).
Buyer puts $10,000 down in cash and signs a promissory note to the seller for the difference (215,000), with say an interest rate of 6.5 percent.
To make a long scenario short the buyer is essentially paying the home seller instead of a lender, and in turn the seller is making an additional profit of 1% while paying off the old mortgage.
While there are benefits to this type of mortgage, some lenders do not allow it, so check with your mortgage company. Another potential pitfall is if the market shifts and the new buyer in the home is losing money on the equity, they do not have any reason to keep paying as the “real” mortgage is still in your name and could be defaulted on, hurting your financial situation.
It is also noted that this is just one general scenario for a wrap-around mortgage, this type of creative mortgage can come in many different shapes but the general principles still hold true (as described above).
These are only two of the many “creative” mortgage programs available to consumers today. Check out tomorrow’s blog post for more information on a variety of different programs, and find out; are creative mortgage programs helpful or harmful?
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