The Option ARM

The Option ARM is a product that has been around for many years. Ten years ago, the average loan amount was over $1 million. Today, the average loan amount is under $300,000. Why? More and more people are becoming aware of these types of loans and are using them to their best advantage. Basically, the Option ARM is an adjustable rate mortgage that offers you several payment options each month.

With most fixed rate mortgages, you pay the same amount every month for the life of your loan, regardless of whether interest rates rise or fall. The interest rate used at the beginning of your loan determines your monthly payments for the next 15, 20, 25, 30 or even 40 years.

An Option ARM is different in two significant ways. First, your payments are recalculated monthly (except during the introductory period). As interest rates change, so may your monthly payments. And second, you have more than one payment option. With most home loans, every month you pay back a little of what you borrowed plus interest. With an Option ARM, you can make the same kind of payment, OR you may be able to choose a payment option lower than the full principal and interest payment (based on the remaining scheduled term of your loan).

The Option ARM offers you more flexibility every month. You'll typically have up to 4 payment options, so you're more in control - more options on your home loan means you'll have more room to manage other monthly expenses. Pay less to free up your funds, or pay more to pay down your loan faster. The choice is yours! Each of the options are always clearly spelled out for you on your monthly statement.

Four payment options? What are they?

• Option 1: Minimum Payment - this is the smallest payment available - it is always interest, but if applicable, there may be some principal embedded in the payment. What is significant about this payment, is that it has the potential to "defer interest." The minimum payment may not be enough to cover all of the interest due for a given month. In that instance, the interest shortage is "deferred." This is called "negative amortization." It means that the amount of principal you owe will be increased by the amount of deferred interest. That deferred interest will now be used in any subsequent monthly recalculation and will be subject to additional interest at the going rate of your loan. The minimum payment is fixed for 12-month increments. At the end of 12 months, the minimum payment can be adjusted up or down by no more than 7.5% of the previous 12-month minimum payment. For example: let's say your minimum payment is $1,000 for the first 12-month period. And let's say that the annual review shows a need to change that minimum payment a full 7.5%. Your new payment will be $1,075 for the next 12-month period. This type of payment requires management and planning - always ask your loan officer to explain the nuances of this type of payment so that you might fully understand it prior to using it.
• Option 2: Interest Only - this payment is just that, Interest Only. There is no payment made against principal. The significance of this payment is that ALL interest due is paid each month. There is NO deferred interest. For example: if you were making a 30-year amortized payment on a loan amount of $100,000 at a rate of 5.75%, your monthly payment obligation would be $583.57. However, you are making an Interest Only payment, and therefore, your required payment will be $479.17, saving you $104.40 for that month!
• Option 3: Full Principal and Interest Payment (based upon the remaining scheduled term of your loan). In the example offered in option 2 above, we spoke of a loan amount of $100,000 at a rate of 5.75%, if you had 360 (30 years) monthly payments left, your payment would be $583.57. However, if you had 333 monthly payments left, your payment would be $601.63.
• Option 4: Full Principal and Interest Payment (based upon a 15-year amortization table). This option is available only if your loan term is more than 15 years. In the example we've been using right along. The mortgage term is 360 months or 30 years. Your payment for this option would be $830.41. You will have accelerated your 30-year amortization schedule. This puts you on a course where the loan will be paid off earlier than the 360 month term.

This type of loan needs to be fully understood prior to closing. Your loan officer is the place to start. He can full explain the options and show you the differences, both pluses and minuses. This loan type is extremely powerful and can help you in many ways. However, if not fully understood and not managed correctly, it can be a hinderance to financial stability.

Appropriate Uses of This Type of Loan: 

People who benefit most from these loans are the following:

• Folks who have uneven monthly income: Commissions, self employed, seasonal income, etc.
• Investors who need to manage their cash flow, balance income and interest expense, or free up funds for other investments
• Investors who typically buy a property, renovate it and then resell it
• Folks looking at retirement, needing to free up cash for vacation or investments, manage their interest expense or make the most of their home Equity
• Savvy Borrowers who want to maximize cash flow, manage their interest expense, or free up cash for investments
• First time home buyers looking for that dream house or those ready to move up into their next home
• Folks looking to sell their home in 5 years or less, but want lower payments during the interim
• Folks looking to consolidate their debt and achieve lower monthly payments and easier cash flow

Using the Payment Options to Your Benefit:

• The Minimum Payment, for most borrowers, should be used sparingly for emergencies or unexpected needs. Your car broke down. The furnace died. Your septic tank backed up. Each of these situations might need to be addressed immediately. Having the ability to underpay on your mortgage can often solve short term cash flow issues. That's why the minimum payment is available
• The Interest Only Payment, can be used by anyone to their advantage. It's the ultimate place holder for mortgages. You cover the monthly interest due on your loan without incurring late or delinquent charges. It doesn't reduce your principal, but it satisfies the financial institution that a payment was made. This option is good for seasonal, commissioned or self employed borrowers where income can be variable month-to-month.
• The traditional Full Principal & Interest Payment (based upon the remaining months of your loan term). You've had a good month. Cash flow is normal. No major problems are on the horizon. Make a normal payment!
• The 15-year Amortized Full Principal & Interest Payment (only available if the term of you loan is longer than 15 years). You've had an exceptional month. You've received your tax return. You've received unexpected money. Go crazy, make a full principal and interest payment, as if it was a 15-year note. Remember, this will accelerate the pay down of your loan, shortening the term.

Consult Your Loan Officer!

Let him help you to understand these loans and advise you on how you might benefit from using one of them. These products do not make sense for some people. Let your loan officer qualify whether they make sense for you. Call us today!

First Call Mortgage Co., Inc 18 Constitution Drive, Suite 8 | Bedford, NH 03110 Phone 603-622-4100 x19 Fax 603-666-3249     This web site may contain concepts that have legal, accounting and tax implications. It is not intended to provide legal, accounting or tax advice. You may wish to consult a competent attorney, tax advisor, or accountant. Privacy Statement