Exotic Mortgage Definition

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Exotic Mortgage Definition

What Is an Exotic Mortgage?

A house loan known as an exotic mortgage provides cheaper monthly payments for the first few years but may be dangerous due to its sometimes complex conditions and higher future obligations. Occasionally, people utilize unusual mortgages to purchase properties that they couldn’t normally afford. For cheaper monthly payments, homeowners might refinance into exotic mortgages. Exotic mortgages, also known as non-traditional mortgages, were previously more prevalent but now only make up a tiny portion of the mortgage industry.

Key Takeaways

  • A form of house loan known as an exotic mortgage has reduced monthly payments for the first few years but is regarded as high-risk due to the larger, potentially unmanageable, future installments.
  • Exotic mortgages come in a variety of forms, including as interest-only, balloon, and payment-option mortgages.
  • Exotic mortgages were subject to stricter regulation after the housing crisis in 2008. Additionally, they lost popularity when interest rates on conventional mortgages reached record lows.

Types of Exotic Mortgages

There are several types of exotic mortgages, all of which provide lower beginning payments than conventional mortgages but carry a higher risk for the borrower. They consist of:

Interest-only mortgages

One kind of unusual mortgage is an interest-only loan. They demand just interest payments for the first few years, as opposed to standard mortgages that require the borrower to pay both interest and a part of the debt each month. That enables a lower initial monthly payment.

Since the interest rates on these mortgages are often adjustable, the initial monthly payment may rise if the rate does. It may also increase if the interest-only term expires and the borrower is required to resume making principle payments. The borrower’s monthly payments can therefore become unaffordable.

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Payment-option adjustable-rate mortgages (ARMs)

A payment-option adjustable-rate mortgage, or option ARM, is another kind of exotic mortgage. In the case of this loan type, the borrower has the option of making a monthly payment that is either the standard full amount, an interest-only payment, or even less than the interest owed.

This kind of loan may, in principle, be advantageous for someone whose income varies greatly from month to month. The risk is that any unpaid interest will simply be added to the principle balance, resulting in interest payments on top of interest.

Balloon mortgage

A balloon mortgage begins with little or no monthly payments, but at a certain time, the borrower is required to pay the lender a large lump amount. The balloon payment typically occurs at the conclusion of the mortgage and completely settles all outstanding debt. The risk here, of course, is that the homeowner won’t have the money available when the balloon payment is due.

Pros and Cons of Exotic Mortgages

An exotic mortgage provides the benefit of enabling borrowers to acquire homes they otherwise wouldn’t be able to afford.

They are assuming a lot of risk in exchange for those smaller monthly payments, which is the trade-off. Their monthly payments with either an interest-only or payment-option mortgage will eventually rise, maybe significantly and beyond their means. They will be required to come up with a substantial sum of money when their balloon payment is due if they have a balloon mortgage.

Everything could turn out okay if everything goes as planned. However, the borrower may not be able to uphold their half of the contract due to a loss of employment, an unanticipated financial emergency, or a drop in house values. The borrower may then lose their house if the lender decided to foreclose on the property. During the housing crisis of 2008, this situation often happened.

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Following the housing crisis, a few unique types of mortgages were outlawed. Others just lost popularity as historically low mortgage rates reduced the attractiveness of exotic loans. However, some are still accessible and could see a revival in the property market in the future.

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