Option ARM Mortgage Loans were created to give the borrower more choices
in their mortgage program. They allow the mortgagee to make a choice with each
payment on what terms they will use to pay the loan back. A payment-option ARM
can be a good tool for the investor who is going to own a property for a short
term.
Payment-option ARMS usually have a significantly lower interest
rate for the onset – first 1 – 4 months – of the loan. It is not unheard of for
the rate to be in the 2% – 3% range. After the initial period the rate levels
out to match that of standard loans.
Generally the way a payment-option ARM works is the borrower is
given three choices for their payments:
A standard- conventional
payment of principal and interest. This payment is determined off of agreed
amortization terms such as a 15 year ARM. With this payment you are reducing
the balance of the loan.
An Interest-Only payment
which is consistent with regular Interest-Only payments where you pay no
principal, but the interest is calculated at the current interest rate terms
agreed to in the mortgage. With this payment you are only paying the cost of
the loan and not paying down the original amount borrowed.
A Minimum-Payment is
usually based off the initial interest rate in the terms of the loan and may
or may not cover current interest expense. If the minimum payment is lower
than the current interest only payment, the difference will be added to the
original balance of the loan. This is called Negative Amortization.
Lenders will typically recast Option ARM Mortgages every 5 years
which will often recalculate your payment. They do this to account for any
negative amortization. Additionally lenders will generally cap the loan balance
at 125%. If you reach the 125% mark they will recalculate your loan and you
will begin paying back principal and interest which would significantly increase
your payment.
