DEFINITION of 'Exotic Mortgage'

A type of home loan that offers lower monthly payments in the first few years, but is considered high-risk because of its difficult-to-understand terms and higher future payments. People often use exotic mortgages to buy more expensive homes than they otherwise could afford. Homeowners may also refinance into exotic mortgages to lower their monthly payments. Exotic mortgages, also called non-traditional mortgages, make up a small part of the mortgage market.

BREAKING DOWN 'Exotic Mortgage'


With an exotic mortgage, payments can increase dramatically after the initial period to twice or more the initial payment. Their payment schedules can also cause borrowers to end up owing more than they originally borrowed.
 
Interest-only mortgages are one type of exotic mortgage. Instead of requiring the homeowner to pay both principal and interest, they only require interest payments for the first few years, which means a smaller monthly payment. These mortgages typically have adjustable interest rates, so the initial monthly payment can jump if the interest rate increases, in addition to spiking when the interest-only period ends and principal repayment is required.
 
Another type of exotic mortgage is the payment-option adjustable-rate mortgage. This loan allows homeowners to choose a different amount to pay each month. They can even choose to pay less than the interest owed.
 
Aside from the problems of unpredictable monthly payments after the introductory period and difficulty in understanding their terms, a major problem with exotic mortgages is that if homeowners originally took them out because they could only afford a very small monthly payment, they may not be able to afford the future payment increases. In a declining housing market where home prices are decreasing, homeowners cannot sell their homes or refinance to get out of their no-longer-affordable exotic mortgages. Their only choices are a short sale or foreclosure. This scenario occurred regularly during the 2008 housing crisis.
RELATED TERMS
  1. Mortgage

    A debt instrument, secured by the collateral of specified real ...
  2. Level Payment Mortgage

    A type of mortgage that requires the same dollar payment each ...
  3. Term Payment Plan

    An option for receiving reverse mortgage proceeds that gives ...
  4. Graduated Payment Mortgage

    A type of fixed-rate mortgage in which the payment increases ...
  5. Nontraditional Mortgages

    A broad term describing mortgages that do not take the traditional ...
  6. Reverse Mortgage

    A type of mortgage in which a homeowner can borrow money against ...
Related Articles
  1. Personal Finance

    Understanding the Mortgage Payment Structure

    We explain the calculation and payment process as well as the amortization schedule of home loans.
  2. Personal Finance

    Top 6 Mortgage Mistakes

    These common errors could end in foreclosure.
  3. Personal Finance

    Make A Risk-Based Mortgage Decision

    Find out how to choose which mortgage style is right for you.
  4. Personal Finance

    Choose Your Monthly Mortgage Payments

    Exotic mortgages allow you to decide how much to pay. Find out how much they really cost.
  5. Personal Finance

    5 Risky Mortgage Types To Avoid

    There are plenty of ways to end up with a bad mortgage. The risks of these five should make every homebuyer think twice before signing.
  6. Personal Finance

    Be Mortgage-Free Faster

    Getting rid of this debt faster has bigger benefits than you might think.
  7. Personal Finance

    How to Use a Mortgage Calculator to Save Time and Money

    Calculate your monthly mortgage payment using the Investopedia's free calculator.
  8. Investing

    Understanding The Mortgage Payment Structure

    While a mortgageā€™s size and term set the baseline, the interest, taxes and insurance all influence the amount of the monthly payment.
  9. Personal Finance

    ARMed And Dangerous

    In a climate of rising interest rates, having an adjustable-rate mortgage can be risky.
RELATED FAQS
  1. What are the best ways to pay off my mortgage quickly?

    Learn how mortgage payments may be reduced and how to save thousands on mortgage loans by lowering the interest and principle ... Read Answer >>
  2. When do mortgage payments usually start?

    Discover when your first mortgage payment is due and how it differs from rent. Learn about the closing process and why you ... Read Answer >>
  3. What are the different types of subprime mortgages?

    Clarify your understanding of subprime mortgages. Learn about the different types, how they work and when they might be beneficial. Read Answer >>
  4. Is there any time I would want to have a zero-principal mortgage?

    As a general rule, entering a zero principal mortgage, or what is commonly referred to as an "interest-only mortgage", is ... Read Answer >>
Trading Center