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Mortgages to Avoid

We recommend that you avoid interest only loans, negative amortization loans, and Option ARM's. These loans are only recommended to sophisticated home buyers. More specifically,

An interest-only mortgage is one that allows borrowers to pay only the interest for some specified period (usually 3-10 years). For that period the required monthly mortgage payment does not include any repayment of principal, though borrowers can make such payments, if they like. At the end of the interest-only period the remaining balance is required to be at a set amount of time. People use interest-only loans in order to reduce the monthly mortgage payment in the first few years of the loan. This means that they are most likely buying a home that is more expensive than what they should be buying and thus we advise against such loans.

A negative amortization loan is a type of loan that not only it does not reduce the amount of money you owe on your home, but increases that amount. In other words, with a negative amortization loan your loan balance increases over time. The main reason negative amortization loans exist is to lower monthly payments even further than interest-only loans. Some folks use loans with negative amortization to get into a house they otherwise can't afford. Usually they believe that they'll have more income in the future. While you do enjoy lower payments today, the cost of a negative amortization loan is that you have to pay more later. Sometimes this can make sense. However, use the strategy at your own risk. As before, it is highly regarded as a poor decision!

An Option ARM is a type of loan that allows you to choose between four payment options each month. Each month you can pay either:

  1. A minimum payment (i.e. effectively becoming a negative amortization loan for that month), or
  2. An interest only payment (i.e. effectively becoming an interest only loan for that month)
  3. A 30 year amortized payment (i.e. effectively becoming a 30 Yr. Fixed loan for that month), or
  4. A 15 year amortized payment (i.e. effectively becoming a 15 Yr. Fixed loan for that month)

The interest rate on these mortgages adjusts monthly, in most cases, and that is where the REAL trouble starts! Even though, the payment flexibility sounds great, the monthly fluactuation of the interest rate makes these loans a NO NO for EVRYONE.

Recently, there have been some Option ARMs that have a fixed interest rate for an initial period. Choose an Option ARM only if the 'fixed period' is longer than the time you are planning to stay at your home (per our quidelines on 'Getting the Right Mortgage') and you are very organized and extremely disciplined about your financials -- since you do not want to end up all the time using this loan as a negative amortization loan.

Best of luck,
Your Financial Ally