By Elizabeth Lucchesi
What is a nontraditional mortgage?
A nontraditional mortgage is a loan that doesn’t have a standard amortization schedule or payment installments. Common characteristics of nontraditional mortgages include flexible repayment terms, less strict qualification requirements and the option to defer principal or interest payments. Private mortgage lenders, like businesses or home sellers, issue nontraditional mortgages rather than financial institutions.
Types of nontraditional mortgages:
A mortgage that operates on a lump-sum payment schedule is called a balloon loan.
Depending on the terms, you may pay only interest for the life of your loan and make one big principal payment at the end, or a combination of interest and principal, with a smaller lump sum due at the end.
Advantages of these loans include low monthly payments and the freedom of cash flow for other investments. Homeowners who know they won’t be in a house very long or those with the resources to pay the lump sum quickly may consider a balloon loan.
An interest-only mortgage allows interest-only payments for some or all of the term, with the principal balance unchanged during the interest-only period. After that, the loan balance begins amortizing, which can significantly increase monthly payments.
Most interest-only loans are called ARMs, meaning that the interest rate will be adjusted a specified number of times each year, causing monthly payments to fluctuate.
An ARM is structured by the number of years interest-only payments are due, followed by how often the interest rate will be adjusted. For example, a “5 / 6” ARM has a fixed interest rate for the first five years, after which the interest rate can change every six months.
A payment-option ARM adjusts monthly and allows borrowers to decide how to repay the loan. Several payment options are available, including 15, 30, or four-year fully amortizing, minimum-and-over-based, and interest-only payments.
Traditional, nontraditional, and nonconforming
Traditional mortgages, also known as conventional mortgages, have straightforward terms. The borrower finances a set amount of money from a lender at an interest rate, fixed or variable, and then makes payments toward the principal and interest for a set amount of time until the loan balance is paid.
Often confused, nontraditional and nonconforming loans are not the same – though nontraditional loans are almost always nonconforming.
Many non-conforming loans, such as FHA and VA loans, operate like conventional mortgages in terms of repayment model and schedule. The defining difference is that nonconforming loans don’t meet Fannie Mae and Freddie Mac’s standards for purchase. They typically have lower requirements for credit scores and debt to income ratios.
Nontraditional loans don’t conform to Fannie Mae and Freddie Mac’s standards and have atypical repayment schedules.
The bottom line
Nontraditional mortgages can be attractive because they offer flexible payment terms for financing a short-term investment and unique situations requiring low upfront costs. This flexibility becomes a considerable risk when paired with higher rates and a borrower needing more resources to pay up.
Before making any real estate or financing decisions, lean into the advice of an experienced realtor and a lender you know and trust. These professionals should clearly explain the loan terms and the best options for your situation.
The information provided here is not investment or financial advice.
The writer is the founder of the LizLuke team at Long & Foster Real Estate. She is also a buyer and seller agent.