Here's The Red Flags You Should Watch When Applying For A Mortgage With Bad Credit
A bad credit mortgage can open up new horizons for you and your family. However, not all mortgages are created equal.
Before you sign on the dotted line, you must watch out for potentially problematic features of some mortgages.
The Dangers Of ARMs
Adjustable-rate mortgages (ARMs) are frequently marketed to bad credit customers as an affordable lending alternative with a higher chance of approval than traditional bank home loans. There are several reasons why you’ll want to be cautious about this type of product.
- ARMs feature fluctuating interest rates that are low initially and increase after a number of years
- The lower rate may seem extremely attractive compared to the APRs you’re able to qualify for on other home loans. However, the savings can quickly be erased once the rate jumps up after the introductory period has ended
- At this stage, you may find that your monthly payment becomes difficult to afford and this may raise your risk of default and foreclosure
It’s important to note the difference between an ARM with an APR that spikes after a few years and a regular mortgage with a floating interest rate. In the second case, your rate may rise or fall with the federal interest-rate but it’s unlikely to jump suddenly and become unaffordable overnight.
If you’d prefer to make a relatively stable monthly payment, you may want to opt for a fixed-rate loan.
Be Wary Of Interest-Only Mortgages
Your monthly home loan payment is made up of two parts: the interest your lender charges you and a small amount of the total loan value that you pay down each month.
- Some loan providers will offer to charge you interest only for the first few years of your mortgage, thus reducing your monthly payment substantially. However, these savings don’t last indefinitely
- Like an ARM, an interest-only home loan features an introductory period during which the cost of borrowing remains low. Unfortunately, when this period ends, you’ll start to repay the equity. Since you’ll have fewer years to pay back the debt, the non-interest portion of your monthly payment will be far higher than it would be on a conventional 20 or 30-year mortgage.
Whenever you receive an enticing offer from a loan provider, you’ll want to read the fine print extremely carefully to find out whether the deal you’re being offered is truly beneficial or not.
By opting to only pay interest initially, you may be setting yourself up for financial difficulties in the future. You’ll get used to budgeting for a smaller payment and suddenly find that your installment shoots up after the initial period ends.
More Years On Your Mortgage Means More Interest
Another common technique some loan providers use to make the monthly payments seem more affordable is to offer an extension of the loan term from the normal 20 or 30-year to a 40-year.
- As mentioned above, the total value of your home loan will be repaid in fixed monthly amounts over the period of your loan
- By extending this timeframe by an additional ten years, you can reduce the equity portion of your payment, although you’ll be paying interest for an additional 120 months. This could add a substantial cost to your loan over the years
The table below illustrates the trade-off between lower monthly payments and higher total interest charges on a $200,000 mortgage repaid over 20, 30, and 40 years respectively at an interest rate of 5.40%.
Loan Term | 20 Years | 30 Years | 40 Years |
Monthly Payment | $1,364 | $1,123 | $1,018 |
Total Interest | $127,480 | $204,301 | $288,626 |
The risks involved in a long-term mortgage increase substantially if you opt for an adjustable-rate. The federal interest rate is close to record lows at the moment. However, when the economy bounces back, the rates could rise rapidly. This could cause your monthly payments to skyrocket.
Reducing Your Risk By Finding The Right Type Of Financing
No matter how good a housing loan deal may look at first glance, it’s essential that you find out exactly how much the loan will cost you in the long term. In addition to this, find out at what point your APR will increase if you opt for an adjustable-rate.
- In general, if a lender offers you an APR or monthly payment that’s substantially lower than most of the offers you’ve received from other loan companies, then you’ll want to investigate its precise terms and conditions. Doing this will ensure that there won’t be any unpleasant surprises in the years to come
- It’s important to note that once you’ve read and signed a housing loan agreement, you’ll be liable to make any payments required in terms of your contract. For this reason, determine exactly what your obligations will be before you finalize your loan deal
Conclusion
Choosing the right mortgage provider is crucial given the long-term nature and high value of this type of loan. To save yourself money over the decades while investing in the property of your choice, you’ll want to ensure that the home loan you sign up for is affordable. Additionally, you’ll need to understand the terms and conditions that come with it.
