What is an Option ARM Loan?
Option ARM loans provide a number of payment options each month ranging from a minimum payment to the full principal and interest payment. This type of loan has become very popular in recent years as it allows first-time homebuyers to purchase a home with a low monthly payment. How Does an Option ARM Loan Work?
Option ARM Loans are an adjustable-rate mortgage (also known as ARM) that provides you up to four payment options each month. The lender sends a monthly statement with up to four payment options, and you select the amount you want to pay and send the slip back with your payment. Most common Option ARM Loan Monthly Payment Options are:
Minimum Payment: Because this payment is low, it's useful for months when you don't have much cash on hand. Unpaid interest gets added to the principal of Option ARM Loans. Interest Only: You pay the interest, but none of the principal. This doesn't reduce your balance, but avoids deferring interest. 30-Year Amortized: This matches the monthly payment of a mortgage amortized over 30 years at your current interest rate, including both principal and interest. 15-Year Amortized: The same as above, but amortized over 15 years. This allows you to reduce your principal faster than any other option. What Are the Advantages of Option ARM Loans?
Option ARMs offer a lot of flexibility for people with fluctuating incomes, provided they are financially disciplined. The advantages of Options ARM Loans are that they allow you to make minimum payments during lean times, and then make up the difference when your income arrives. What Are the Disadvantages With Option ARM Loans?
The biggest disadvantage of an Option ARM Loan is that those enticing initial rates are short-lived. The low minimum payments that make these mortgages so attractive can increase dramatically. In addition, every five years the loan is recast-and when that happens, the minimum payment can be pushed even higher. Additionally, if you defer too much interest, your loan is automatically recast and you have to start paying the fully amortized rate. Another potential downside of Option ARM Loans is that they're more complicated than most other mortgages. Home buyers may be seduced without fully understanding how much the minimum payments will increase over the long-term.
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