How does an option ARM loan works?

Answer 1

The basic idea: what you are allowed to PAY is not the same as what you are CHARGED.

Once you let that sink in, it's actually a very powerful way to manage your cash flow. When you pay _less_ than what you're charged, that process is called "negative amortization". That's not always bad, though it often has bad press. It is a terrific way to rebalance underperforming equity.

Each month you choose from 4 payment options: the start rate (as low as 3/4% (three quarters of one percent), interest-only, 30yr Amortized (or 40 yr), and 15yr (if you get ambitious). "Amortized" means the loan will be paid off in that many years. Interest Only means the balance won't go up or down, you're just paying debt service.

The start rate _typically_ lasts five years, increasing 7.5% of the _payment_ per year (i.e. a $1000 minimum the first year will become $1075).

For more information see http://www.rogerv.com/option_arms.htm

Answer 2

There are several different lenders that offer Option ARM's, so each may have their own little twist, but here's the basics:

Each month you have 3-4 different payment 'options', these normally include a minimum payment, Interest Only, 30yr term, and 15yr term payment amounts.

The minimum payment is just what it says, the MINIMUM payment you have the option to make every month. It is always a payment that is less than the I/O payment amount. What this means for the borrower is that they are deferring interest to the end of the loan, or in other words their loan balance GROWS every time they make a minimum payment. This is also known as a Neg-Am mortgage. The minimum payment can start as low as 1.5%, but this is NOT your interest rate, it is your payment start rate. Many people get confused on this.

The Interest Only payment option is just that, interest only. Therefore your balance doesn't grow, but it also doesn't go down, so you never build equity through the payments.

And the 30yr and 15yr payment options are payments based upon whether you would like to pay the loan off in 30 or 15 years if you made those payments every single time.

Many people say these are horrid loans, and they can be IF you are not educated and disciplined in their proper usage and purpose.

In my opinion this is a great program for self-employed seasonal workers (roofers, masons, landscapers, exterior painters, etc for example) who have steady consistent work through out the good weather months, but may have sporadic or less cash flow during the winter. They also work well for landlords in some cases, because the landlord, if they ever have a unit go un-leased for a month or two, can just make the minimum payment for that month and not go late or in default of their mortgage.

THIS IS NOT A GOOD PROGRAM IF, you are just looking to buy more home than you could otherwise afford on a full principal & interest payment.

Again, they have specific advantages that give good benefit, but if used inappropriately they can cause severe problems for borrowers that consistently just make the minimum payment 'because they can'.

I hope that explained what an Option ARM is, and how it could be beneficial or harmful in it's use. Each lender has different quirks, like Fixed Rate Conversion Options, lifetime interest rate caps, payment start rate amounts, etc...I suggest you ask LOTS of questions if you are contemplating this type of loan.

Also, because it is an ARM (adjustable rate mortgage), the interest fluxuates with the market and what ever index the program runs on (not all loans run on the same index).

Answer 3

An ARM loan is an Adjustable Rate Mortgage; typically, they start at or just lower than the current fixed rate of interest and the interest rate increases "x" amount per year until you reach the cap of the loan, which could be anywhere from 10% to 18%.

It's a gamble. It's possible that rates could drop, but i'd be willing to bet they will continue to rise a bit or stay even for a while before they significantly increase again as we saw happen in the early 80's.

As low as rates are right now, you're likely far better off to stay with a fixed rate loan. That way, other than the increase annually of taxes and insurance, you're going to have, more or less, the same payment each month.

Better than asking on a forum such as this, you'd do far better to consult with a mortgage banker about what the potential growth rate of the loan *could* be in a worst case scenario and make your decision from there.

Answer 4

An option ARM allows you a choice of 4 mortgage payments each month. You can choose a payment based on a 1.5% interest rate, an Interest only payment, a 15 year payment or a 30 year payment. In most cases, your interest rate will adjust every month. The 1.5% interest rate is a "teaser rate". In fact, you will be accruing interest that will not be paid in full by the lowest payment choice. It will be added to your balance and you will now have negative amortization. In other words, you may end up owing more on your mortgage than you originally borrowed.
This is a great loan for people who have variable income but are disciplined enough to make lump sum payments when times are good. That way you can avoid negative amortization but still have the flexibility of choosing the payment that works for you each month.

Answer 5

Email me and I will send you a graph that explains this and shows you how it works and what you will lose each month if rates dont go up.