What is an alternative mortgage?
An alternative mortgage is a home loan with terms that differ from conventional, fixed-rate mortgages and may come with higher interest rates. In addition, there are several types of these alternatives available to homebuyers who can’t meet the requirements of a traditional mortgage.
A standard fixed-rate mortgage remains one of the most popular loans because of the stability it provides.
Thanks to the fixed-rate component of the mortgage, your interest rate stays the same for the term of the loan, usually 15 or 30 years. Assuming that you make the payments as scheduled, you know exactly when you’ll pay the mortgage off.
Even so, if a conventional mortgage payment is too high, there are alternative mortgages available. Alternative mortgages are also an option for those who haven’t established credit or lack enough employment history to show a steady income to qualify for a conventional loan.
Terms vary depending on the mortgage, but some common alternatives include:
- Adjustable-rate mortgages (ARM)
- Adjustable-rate mortgages with a temporary fixed interest rate
- Negative amortization mortgages
- Pay-option, adjustable-rate mortgages
- Interest-only mortgages
- Balloon mortgages
There are risks associated with alternative mortgages. Many products, like the negative amortization loan and the interest-only mortgage, don’t actually pay down the loan. If home values stagnate, borrowers may they’re upside down (their loan’s value is more than the home is worth).
With a balloon mortgage, a large portion of the loan is repaid with a single payment at the end of the loan period.
To be sure, a key factor with adjustable-rate mortgages is that the interest rate resets after a certain period, and that can lead to a sizable payment increases that make your monthly payment unaffordable.
Alternative mortgage example
Anna and Mark want to buy a home for $200,000. They can’t afford the payment on a 30-year fixed-rate mortgage, so they decide to take out a 5/1 ARM, with an initial fixed rate that adjusts after five years based on a specified index and then every year after that. Ideally, their home will appreciate in value during the intro period so that they can refinance into a conventional, fixed-rate mortgage before the payments are increased.