If you’re unable to qualify for a conventional loan or just aren’t interested in one, you may be wondering what other types of mortgages are out there. There are tons of options to choose from, many of which fall under the umbrella term of “nontraditional” mortgages.
What is a nontraditional mortgage loan, though, and is it the right choice for you?
A nontraditional mortgage is a unique loan that doesn’t fit the requirements for a conventional or even unconventional loan. Nontraditional mortgages are usually easier to qualify for in terms of credit score and debt-to-income ratio (DTI) but can be risky for both lenders and borrowers.
These mortgages tend to have unusual repayment terms and may allow borrowers to defer their payments or pay only interest until the end of the loan. It’s important to note that Rocket Mortgage ® doesn’t offer these types of loans.
Nontraditional mortgage loans are usually characterized by the following traits:
With a traditional government-backed or conventional mortgage, the terms of repayment are fairly straightforward. To finance a home or property, you borrow some amount of money from your lender at an interest rate that is either fixed or variable. Then, you make payments toward the interest and principal you owe until everything is paid off, after which you own the property outright.
With a nontraditional mortgage, these terms of repayment are a little different and give other options to home buyers who may not qualify for a government or conventional mortgage. There are several different types of nontraditional mortgage products, but the thing they each have in common is the option to get rid of the regular payment model in favor of a more flexible payment schedule.
For example, the buyer may be able to make payments just toward the interest of the home loan until the loan term ends, when the principal is due. Alternatively, a lender might allow more flexible payment deferral options with little consequence besides increasing the amount owed in the long run.
Nontraditional loans are often confused with unconventional or non-conforming loans. Nontraditional loans and non-conforming loans are not the same thing – though nontraditional loans are almost always non-conforming. So, what exactly is the difference, and how can a loan be both?
Non-conforming loans are any loans that don’t meet Fannie Mae and Freddie Mac’s standards for purchase, meaning they’re not conventional. However, many of them still operate like conventional mortgages in terms of repayment model and schedule, for example, FHA loans and VA loans. Even though you pay off an FHA loan the same way you would a conventional one, loans like these are considered non-+conforming because they are government-backed and often have lower requirements for credit score and DTI.
Nontraditional loans are loans that not only don’t conform to Fannie Mae and Freddie Mac’s standards, but also don’t have typical repayment schedules. Unlike FHA or VA loans, with a nontraditional loan, you may not even have to make payments every month. You might be paying only interest for a few years – or for the entire life of the loan.
There are three main types of nontraditional mortgage loans: balloon loans, interest-only mortgages and payment-option adjustable-rate mortgages (ARMs). Again, Rocket Mortgage doesn’t offer these loans and we’re mentioning these for informational purposes only.
A balloon loan is a mortgage that operates on a lump-sum payment schedule. This means that at some point in the life of your loan, usually at the end, you’ll have to pay the remainder of the balance all at once. Depending on your lender, 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 somewhat smaller lump-sum payment at the end.
With a balloon loan, you’ll have low monthly payments and the ability to use your money for other things, such as building credit or savings, before making your eventual lump-sum payment. These loans can be a good idea for:
An interest-only mortgage is similar to some balloon loans in that it may allow a borrower to only pay interest on the loan for their monthly payment rather than interest and principal. Unlike a balloon loan, however, interest-only mortgages usually only allow you to pay just the interest for a set number of years. After that, your balance begins amortizing, which can greatly increase your monthly payment.
Some interest-only loans are ARMs, meaning your interest rate on the loan will be adjusted some number of times each year based on the current rates, causing your monthly payments to go up or down. These loans are often structured in a 5/6 format with the 5 being the number of years you’d pay only interest and the 6 indicating that your rate will be adjusted every 6 months.
There are interest-only fixed-rate mortgages as well, but they are very rare. ARMs can be more expensive long-term, so if a rate that is guaranteed not to increase sounds better to you, you may instead want to refinance to a conventional fixed-rate loan.
A payment-option ARM adjusts monthly and allows borrowers to decide how they want to pay down the loan. Borrowers are given a number of payment options to choose from, including 4-, 15-, or 30-year fully amortizing payments, minimum-and-over based payments and even interest-only payments, similar to a balloon loan.
Payment-option ARMs can be very high-risk to borrowers, since there is a good possibility your monthly payments will increase and the amount of debt you owe may actually increase as well, depending on your rate and how much over minimum you’re paying each month on the mortgage. These loans can be beneficial to those working with shorter-term investments but may prove too risky for homeowners seeking a good long-term loan.