The chances of the average family getting a mortgage in today’s soft market have only changed slightly since last year, but even this small change has got a lot of people considering more non-traditional mortgage options.  Although these alternative mortgage options can come with lower interest rates, lower payments and more flexibility, they also come with some greater risks. 

Before you decide to forgo the traditional financing, take time to learn the pros and cons of these 5 Alternative Mortgage Options.

The Lease To Own Option:

Instead of purchasing a home completely, many buyers are interested in a “test drive”, so to speak.  In a lease to own agreement, the buyers will actually rent a property temporarily (or for as long as the agreement indicates) paying rent to the seller.  With each payment the seller receives, they put a portion into an escrow account.  This is often a popular option when a buyer really wants to purchase a property, but does not have the cash for a deposit.  At the end of the lease term or, if the agreement specifies any time during the agreement, the buyer may offer to purchase the property and use the escrow and earnest money against their offer.  It is the seller who runs the most risk in this situation because the buyer may walk away from the deal.  In most cases, where the agreement is written as such, the seller can retain the earnest money and money in escrow, if a buyer walks away from the deal, but the property is off the market during the Lease To Own period and may have sold had the buyers been serious. 

The Cash Out Mortgage Option:

Current homeowners who have built up enough equity in their first homes can often refinance and receive cash for the difference.  This money can be used as a down payment on another property.  This is a risky option when you consider the volatile housing market.  Should housing prices drop drastically you could end up owing more than your home is worth.  This is basically a loan insured against your house, much like the original mortgage, and you shouldn’t take the risk unless you are sure that your home’s value will not depreciate.

The Balloon Mortgage Option:

This option works great if you are expecting a big inheritance or some kind of lottery winning in your future.  During the first 5 years, or however long the financing contract stipulates, a buyer pays a low monthly payment.  However, the buyer agrees to pay all remaining principle at the end of that period, in one payment.  If your inheritance falls through or your lottery numbers don’t come up, you are going to have to refinance.  This means more money for closing costs and generally much higher interest rates.  Worse, if you don’t qualify for the refinancing, you are heading into foreclosure for sure.

The Pay Option Arm:

Most borrowers are familiar with variable rate mortgages.  You get a loan at a time when interest rates are low and you maintain that low rate until the market changes.  If the rates go up, so does your payment, but with the Pay Option Arm, you have a variable rate mortgage and your rate can go up or down, but you have agreed to one monthly payment amount regardless of the interest rate.  Now this doesn’t mean you are making out, it simply means you know what your monthly payment will be.   But if rates go up and your payment doesn’t even cover that month’s interest, the interest will be added to the principle and you could quickly owe more than your house is worth. 

The Interest Only Option:

With the interest only mortgage you make only interest payments for the first 10 years of the loan.  Now, although this usually means a pretty low payment for those first 10 years and 10 years of time to build a solid nest egg, it also means, after 10 years, you still don’t own any part of your home.  You have built up no equity.  Also, after 10 years of low payments, your principle payments will likely be higher each month.  These loans are fairly risky for the lender as well, so it is rarely offered to inexperienced buyers.