For example, with a traditional mortgage loan, your loan is amortized over the repayment period, usually 15 or 30 years. You’ll pay fixed installments over the life of the loan, including principal and interest until you reach a zero balance at the end of your loan term. With nontraditional mortgages, however, you may get more flexibility with your repayment. For instance, you may only have to pay interest for a set period, deferring any principal payments until the interest-only period ends.
How a Nontraditional Mortgage Works
For the most part, nontraditional mortgages serve the same purpose as traditional mortgages. Where nontraditional mortgages differ is in how they’re repaid. Instead of amortizing the loan amount and giving you fixed installment payments over your repayment period, lenders typically offer some flexibility. The terms for your repayment vary depending on the type of loan that you have. Your payments might be interest-only for a while, after which you’d pay the principal amount in full—or you may be able to avoid paying principal and interest altogether until your loan matures. In some cases, you may even be able to choose how you manage your monthly payments.
Types of Nontraditional Mortgages
There are three primary types of nontraditional mortgage loans: interest-only loans, balloon-payment loans, and payment-option ARMs. Here’s how each one works.
Interest-Only Loans
As the name suggests, borrowers only have to make interest payments on their loan until a predetermined time, which can be as long as 10 years. At that point, the lender may amortize the loan over the remainder of the repayment period or require a lump-sum payment of the full amount.
Balloon-Payment Loans
Balloon mortgages are generally short-term home loans that require a large lump-sum payment when the loan matures. Depending on the structure of the loan, payments leading up to the maturity date may be interest-only or principal plus interest. However, these payments are usually not enough to get to a zero balance by the time the loan term is over. In some cases, you may even be able to defer both principal and interest; you’d simply pay the loan in full when it matures.
Payment-Option ARMs
With payment-option adjustable-rate mortgage (ARM) loans, lenders effectively allow borrowers to select how they want to pay down the loan. You’ll be given a number of options from which to choose, such as:
Traditional amortizing payments over 15, 30, or 40 yearsInterest-only paymentsA minimum payment set by the lenderPayment of any amount that’s higher than the minimum
Because the interest rate is adjustable, this loan option typically starts out with a temporarily low interest rate. After the initial rate period expires, the interest rate can fluctuate based on market conditions.
Do I Need a Nontraditional Mortgage?
A nontraditional mortgage isn’t necessary for most homebuyers, but if you have unique needs that are best met by a nontraditional mortgage, it can be worth your while. For example, nontraditional mortgages can be easier to get because they have lower standards for creditworthiness and debt-to-income ratios than traditional mortgages. Additionally, these loans are generally better suited for people making a short-term investment or who need a loan with low initial costs.
Alternatives to a Nontraditional Mortgage
You can use several traditional mortgage products to meet your needs, and for most people, those are enough. For example, conventional mortgage loans can come in the form of fixed-rate loans, adjustable-rate loans, jumbo loans, and more. There are also construction loans and similar short-term options if that’s your reason for considering a nontraditional mortgage loan. If you’re thinking about a nontraditional home loan because your credit score is low, FHA loans are available for people with credit scores as low as 500 with a 10% down payment.
Pros and Cons of a Nontraditional Mortgage
Pros Explained
Easier to qualify: If you’re struggling to get a traditional mortgage loan because your credit score is low or your debt-to-income ratio (DTI) is high, you may have success qualifying for a nontraditional mortgage. Can make monthly payments more affordable: If you’re making a short-term investment and don’t want to deal with regular monthly payments, you may be able to get by at the beginning term of your mortgage with interest-only payments, a minimum payment, or no payments at all. Good for short-term needs: Because of the risks involved with nontraditional mortgage loans, they may be worth considering if you have a unique short-term need—for example, you’ve bought a fixer-upper you intend to flip for a profit—and don’t plan to hold onto the loan for very long.
Cons Explained
More expensive than traditional mortgage loans: Because of how nontraditional loans are structured, they carry higher risks for both the borrower and the lender. As a result, you can generally expect a higher interest rate on this type of loan. Can be risky for some: Having lower upfront payments can be appealing. But if you can’t afford the balloon payment—or if your interest rate increases enough on a payment-option ARM that you can no longer afford your loan—then a nontraditional loan could ultimately do more harm than good. Building equity can be difficult: If your payment arrangement includes paying little or none of the principal balance, you’ll have a hard time building equity in your home. And if the value of the property drops, you could end up underwater on your mortgage.
How To Get a Nontraditional Mortgage
Because nontraditional mortgages are generally designed for unique situations, they’re not as common as other conventional loans and government-backed loans. As a result, finding a lender that will offer a nontraditional mortgage can be difficult. If you’re considering a nontraditional mortgage, speak with a mortgage broker who might know lenders that provide these loans in your area. You can also search online for lenders who specialize in these types of products. Whether you’re working with a mortgage professional or doing the research on your own, the important thing is that you take your time to shop around and compare multiple options—including traditional home loans—before you make a final decision.
