Whether it is lending or borrowing money, it always involves some risks into it, and when it comes to home loans, the risks seem to be even higher. This is because the amounts involved in home loans are very high and such loans are offered for a much longer time.

These loans therefore, poses a significant risk to both the lenders as well as the borrowers which ideally both should consider well before getting into such a huge commitment and investment.

  • As for the lenders the risks involve engaging their money on you for a longer period of time though in case of defaults, they can take your home away and resell it to recover their money.
  • As a borrower, your risks seem to be higher as you may lose the home if you default and have to fulfil your responsibility diligently for a long time.

Therefore, in order to prevent your risks, you should know the types of home loan offers that you should avoid for sure, even if the home lending offers seem to be to good to be true. In most of the cases, they are.

Things that make mortgage risky

If there is anything that you may have learnt from the subprime meltdown experienced by the home lending industry in 2008 is that you should always proceed with extreme caution when it comes to borrowing money to buy or refinance your home.

A lot will depend on the type of mortgage you choose. Your choice will make the difference in:

Ideally, there are few specific types of home lending offers that you should avoid because you may soon have trouble with repaying it.

Before you find out that taking out the particular home loan was a bad idea for you, you should first know why mortgage is a risky proposition. Ideally, risk home loans have got nothing to do with the housing crisis or whether you take it from a traditional bank or any other alternative sources such as https://www.libertylending.com/. It is all about the mismatch of the loan product with the repayment ability of the specific borrower.

Typically, all loan products are specifically designed for a particular audience and the problem arises when these are matched with the wrong borrowers. Lenders often say that you can always refinance your home but that is true only when the home prices are rising and not otherwise.

A few statistics to corroborate

If you go by the housing market statistics according to the Mortgage Bankers Association’s National Delinquency Survey, the types of loans that had the highest percentage of foreclosure were the subprime Adjustable Rate Mortgages or ARM. This had a start rate for foreclosure of 3.39%.

Therefore, ARMs are one specific type of mortgage that you should avoid. It is their ever-changing interest rates that makes it a particularly risky mortgage product for any borrower who is in less-than-ideal financial conditions.

On the other hand, by comparison, the other types of loans had different foreclosure start rate that were significantly low when it is matched with the ARMs. For example:

  • The VA loans had a foreclosure start rate as low as 0.70%
  • The prime fixed loans had the same poised at 0.71%
  • The FHA loans had it at 1.02%
  • The prime ARMs at 1.96% and
  • The subprime fixed loans had a foreclosure start rate of 2.3%.

This data indicates that for a subprime borrower, any type of home loans can be a bad idea. However, that does not mean that if you are a prime borrower, you will never be at risk. Even a prime borrower can get into trouble if they do not understand ARMs.

Fixed Rate Mortgages

Just like the ARM the Fixed Rate Mortgages can also prove to be detrimental to the borrowers. Ideally, the borrowers with FRMs may have a low rate of foreclosure, but that does not mean that it will be a good idea always.

If you take on a fixed rate mortgage for as long as 30 or 40 years, it will cost you more eventually because the longer is the time you borrow the money for, more will be the interest paid by you in the end.

Since most people cannot afford to throw away that amount of money, FRMs can be a bad idea especially if you do not have enough money saved for your retirement.

Interest Only Mortgages

IO or Interest Only Mortgages are another type of home loan that you should avoid, especially if you are known not to be very disciplined with your money management. This type of loans requires paying higher amounts when you can afford to do so.

Ideally, IO mortgages are good for people who have an irregular income now but a potential for a significant increase in income in the future. However, the downside of this type of loan includes:

  • The higher interest rates as compared to a conventional fixed-rate mortgage and
  • The high risk of defaulting taking the reduced monthly interest factor too lightly.

The IO mortgages are suitable for the financially sophisticated borrower. It is considered to be risky for others for any one or more of these following reasons:

  • You cannot afford to pay the significantly higher monthly payments as the interest-only period ends
  • You cannot refinance your home due to too little to no equity
  • You cannot sell your home as the home prices have declined
  • You keep this loan for the whole life of it thereby paying more interest than a conventional mortgage and
  • You face a large balloon payment of principal in the end of the term due to the structure of the loan.

All these issues, if grave, can cause you to lose your home and is a slightly less-bad scenario, it will simply cost you much more.

Lastly, avoid those VA loans and Federal Housing Administration loans that require 0% to 3.5% down payment as you will not be able to refinance if the home prices drop. Therefore, choose wisely.