Final answer:
One risk of nontraditional ARMs is the inclusion of penalty terms in the agreement. These terms refer to additional fees or charges that borrowers may have to pay if they do not comply with certain conditions of the loan. The use of penalty terms in nontraditional ARMs is now severely limited.
Step-by-step explanation:
One risk of nontraditional ARMs is the inclusion of penalty terms in the agreement. These penalty terms refer to additional fees or charges that borrowers may have to pay if they do not comply with certain terms and conditions of the loan agreement. Nontraditional ARMs were notorious for having complex and often unfavorable penalty terms.
For example, a penalty term could be a prepayment penalty, which is a fee charged to borrowers if they repay the loan early. Another common penalty term is the payment shock, where the interest rate jumps significantly after a certain period, leading to a sudden increase in monthly mortgage payments.
However, it's important to note that the use of penalty terms in nontraditional ARMs is now severely limited because of regulations and reforms put in place to protect borrowers from predatory lending practices.