7 Mortgage Loan Types To Avoid | LowerMyBills (2024)

Most homebuyers have options when it comes tochoosing a mortgage. But some loans carry more risk than others. Here’s a look at some of the more risky mortgage loans.

What Makes a Mortgage Risky?

Mortgages are riskier when they have terms that make it more difficult for both the lender and borrower to be sure it will be paid off.

Missing monthly payments is the most common way borrowers default on a loan, often because their income has declined or their mortgage type allows forincreases in the interest rateor monthly payment that the borrower can’t afford.

Here are seven types of mortgages that carry increased risk.

1. 40-Year Fixed-Rate Mortgages

Borrowers taking out 40-year mortgages with a fixed rate stretch their loan payments over a longer time. That reduces the monthly payment, but 40-yearfixed-rate mortgagesoften come with higher interest rates than their30-yearcounterparts. Plus, you’ll be paying interest on the loan for those 10 extra years.

2. Adjustable-Rate Mortgages

Theinterest rateon anadjustable-rate mortgagewill change from time to time. While rates can go down, they also can go up — which could make it more challenging to afford your monthly payment.

3. Balloon Mortgages

Balloon mortgages require borrowers to make a single large payment at a specific point in their loan term, usually the final payment. While the low monthly payments may be attractive tofirst-time homebuyers, failing to have the funds to make a larger payment that may run tens of thousands of dollars will put you at risk of default.

4. Interest-Only Mortgages

An interest-only mortgage requires the borrower to pay only the interest on the loan each month, which means you’re not paying down the principal. After a set number of years, borrowers start paying down the principal in addition to the interest, which can make the monthly payment increase substantially.

An additional risk is that most interest-only mortgages are ARMs, which means your interest rate can increase.

5. Loans With No Down Payment

Loans backed by theDepartment of AgricultureandVeterans Affairsrequireno down payment. That makes it easier to buy a home, but it also means you start out with zeroequity. If the value of your home decreases, you could end up owing more than the market value of the house.

6. Reverse Mortgages

Reverse mortgages are for older homeowners seeking sources of income that let them stay in their home in their later years.

With a reverse mortgage, the lender pays money to the homeowner and the balance on the home increases. The loan doesn’t need to be repaid until the borrower no longer lives in the home, and usually is done by selling the home. Reverse mortgages build debt over time, so there’s less equity in the home when it’s sold, leaving the homeowner with less money to live on or to pass on to their heirs.

7. Subprime Mortgages

Subprime mortgages are targeted at homebuyers with poor credit who may struggle to get approved for aconventional mortgage.

With a subprime mortgage, lenders will approve borrowers with poorer credit for a mortgage that usually has a higher interest rate to compensate for the added risk. Subprime mortgages also are often ARMs, which means the interest rate could increase.