Nontraditional Mortgage

What is 'Nontraditional Mortgage'

Nontraditional mortgage is a broad term describing mortgages that do not have standard conventional characteristics. Generally, this can refer to any type of mortgage that does not conform to a standard amortization schedule or does not have standard installment payments. Nontraditional mortgages will usually require higher rates of interest due to higher payment risks associated with the loan.

BREAKING DOWN 'Nontraditional Mortgage'

Nontraditional mortgages may be extended to borrowers in nontraditional situations. They can also be offered to subprime borrowers who are willing to pay higher rates of interest for alternative terms. Additionally, some borrowers may simply choose nontraditional mortgages because of the flexibility they offer.

Some of the market’s most common nontraditional mortgages include balloon mortgage loans, interest-only mortgages and payment option adjustable rate mortgages (ARMs).

Building Developers

Balloon payment and interest-only loans are two types of mortgage loans commonly used by developers. These loans generally require higher interest rates and offer deferred payments. Deferred payment loans are often issued for short time periods and can be beneficial for building developers who do not yet have collateral to secure a loan.

In balloon payment loans, both the principal and interest can be deferred until the maturity date at which time the borrower is required to make a lump sum payoff. Balloon payment loans can also be structured with interest-only payments. In an interest-only loan the borrower pays regular payments of only interest and then makes a lump sum principal payment at maturity. In the case of building development, many developers will use a take-out loan at maturity or refinance a balloon payment loan with collateral once it has been built.

Payment Option ARMs

Payment option ARMs are one of the most flexible nontraditional loans offering numerous payment options for mortgage loan borrowers. These loans follow the adjustable rate mortgage framework however they give borrowers the option to choose the type of payment they would like to make each month.

Payment option ARMs will require a fixed rate interest payment for the first few months or years of the loan. After that the loan will reset to a variable rate loan, usually charging a high margin to compensate lenders for some of the higher risks. In a payment option ARM, the borrower can choose from several options offered by the lender when making their monthly installment payment. Payment options typically include a low fixed rate option usually based on the introductory period rate, an interest-only payment, or a 15 or 30-year fully amortizing payment.

Payment option ARMs can be complicated for both borrowers and lenders since they will involve negative amortization. With a payment option ARM any unpaid principal or interest below the standard payment amount will be added to the borrower’s outstanding principal, increasing the amount of interest they are charged on subsequent payments.