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MortgageWatch from MarketWatch101
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What is an Option ARM: It is an ARM mortgage / loan where interest rate
adjusts monthly and the payment adjusts annually. The borrowers are offered options
on how large a payment they will make. The options include interest-only, and a
"minimum" payment. The payment is usually less than the interest-only payment. The
minimum payment option results in a growing loan balance - also called "negative
amortization".
Does you interest rate adjusts monthly? Does your loan have negative amortization?
You got yourself a Option ARM.
Facts about Option ARM:
- The option ARM gives you the lowest first year payment option.
- If you want to buy a house to sell it at a profit after remodelling or fixing it,
this is your option.
- As long as the real estate market prices are on the rise, this option is good. Increase
in real estate prices may offset the negative amortization.
- The rule that minimum payment can rise by no more than 7.5% is not completely true.
There are two exceptions -
- Every 5 to 10 years the payment will be recast to become fully-amortizing. The payment
will be raised such that the loan will be fully amortized in the remaining term.
This is when "payment shock" attacks normal humans!
- When the negative amortization can vary between 110% to 125% of the original loan.
When this number is exceeded (sometimes in less than 5 years) the loan will be fully
amortized.
When real estate market plunges or even remains steady, negative amortization hits
you hard.
For those who elect the "minimum payment" option - expect to face "payment shock"
when you see increase in payments that you may not be prepared for.
What can you do if you had locked yourself into this type of loan?
- Find a ARM option with the lowest Margin. Margin is the % added to the interest
rate index to arrive at your loan's interest rate.
- Try to make a high initial payment. Ask for the highest interest rate option. Since
the initial payment is determined by the interest rate in month 1, you should select
the highest rate that results in a payment with which you are comfortable. Asking
for a higher rate sounds a little strange, but remember, the quoted rate holds only
for one month.
- Evaluate various interest rate scenarios and payments. This will cushion your "payment
shock" when you come face to face with it.
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