Option ARMS- The Facts

When choosing a mortgage, consumers have more and more programs to choose from these days. Flexibility is key and one product, called an Option ARM, can provide just that.  The loan is originally known as a negative amortization loan.  Used as a financial planning tool, the negative amortization loan is an excellent vehicle.

The Power to Choose

Option ARMs can give you the flexibility of an adjustable rate mortgage with the security of a fixed minimum payment. Up to four payment options are available each month, which allow you to choose the payment that best fits your needs.

Option ARMs allow you to choose from a minimum payment, an interest-only payment, a 30-year or a 15-year amortization payment.

For example, let's say you're in sales. This month sales aren't so hot and money's pretty tight, so you choose to make an interest-only payment. The next month, sales are much better and you can afford to make a 15-year amortization payment.

Understanding Your Options

Minimum Payment

The minimum payment is the lowest payment option you can choose each month. Each year, your minimum payment may change, but it can only increase a certain percentage of the previous year's minimum payment amount. Every five years, your loan gets recalculated to help you stay on track to pay off your loan. After each recalculation, your new minimum payment is based on your current interest rate, your unpaid principal balance and your remaining loan term.

Interest-Only Payment

The interest-only payment is the second lowest payment option and is equal to the amount needed to repay the interest due each month.

15-Year and 30-Year Amortization Payment

If you decide to make the 15-year or 30-year amortization payment, you're paying an amount that is needed to pay off your loan in 15 or 30 years (respectively) from the date you closed your loan. The 15-year payment is the higher of the two and it pays down your loan's principal balance the fastest.

Benefits of Option ARMs

You have the benefits of a lower rate because it's an adjustable rate mortgage. The introductory rates for this type of loan program can be as low as 1%.

If you choose to pay the minimum, you can significantly increase your cash flow for any given month. This can be a great help if you have high-interest credit cards to pay off, you want to save money for your children's college fund, invest it in your 401k, or just want to save for a rainy day. You get the flexibility to manage your finances according to your current needs.

Option ARMs allow you to let your home equity work for you. If you make the minimum payment, you're deferring interest. However, your home is most likely appreciating in value. It's as if your home equity is making part of the payment for you.

Deferred Interest

Choosing the minimum payment may result in deferred interest, also known as negative amortization. It's like making the minimum payment on your credit card, however, the interest is lower and it is usually tax-deductible*.

The maximum deferred interest is generally 15% of your original loan balance. If the maximum deferred interest is exceeded, a new minimum payment is calculated.

Who Should Consider an Option ARM

Because of its flexibility, Option ARMs are a great choice for anyone who is looking to consolidate their debt. It's also good for people who don't have a fixed income such as people who work on commission, investors, or those who are self-employed. It can also come in handy for people who have had a major lifestyle change, such as getting divorced or changing careers.

Option ARMs are a great way to get the flexibility you need to manage your finances. If you need the flexibility to increase your cash flow from month to month or the ability to choose the mortgage payment that best fits your needs, an Option ARM may be a very good choice for you.

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