Mortgages Made Simple with Rick Gundzik

Sunday, May 15, 2005
Option ARMs - Are they a good option for you
Option ARMs have become extremely popular lately, representing close to 50% of all loan volume at a major nationwide lender. They used to be called 'Negative Amortization' loans, but seeming to be too negative a name, some clever marketer renamed these loans 'Option ARMs.'

The term Option ARM comes from the fact that you have 4 payment options each month; 1) a low teaser rate payment, 2) the Interest only payment, 3) a Principal and Interest payment, 4) and the 15 year Principal and Interest payment. Let me break these down for you.

Option 1 - Generally these loans start with a low teaser rate of 1%. Your payment is calculated at this rate.
Option 2 - Interest payment at the fully indexed rate
Option 3 - Principal and Interest payment at the fully indexed rate
Option 4 - 15 year Principal and Interest payment at the fully indexed rate.

The fully indexed rate is approximately 5.5% today and is calculated by taking the margin plus the index. The most common index being used today is the MTA. You'll also hear the COFI, COSI, CODI and LIBOR mentioned as indices. The margin ranges from 2 to 4% and is derived from various factors. But ASK your loan officer what the margin and index are because it will determine your payment. (The next blog entry will discuss how ARMs work, margins and indices)

The great benefit of this loan is if your income fluctuates, such as a salesperson, you can make any of the payments. If you have a big month, pay the higher payment. A lean month or unexpected repairs around the house, simply pay the lower payment. So this loan gives you choices.

The 'Negative' aspect is much worse. Let's take a typical $300,000 loan (common in high cost areas).
Option 1 payment = 964.92
Option 2 payment = 1375.00
Option 3 payment = 1703.37
Option 4 payment = 2451.25

As you can see the low payment is $738.45 lower than the payment you would be making on a normal loan. This difference is ADDED on to your principal balance. In this example, if you paid the lowest payment for 1 year at the end of the year you would now owe $308,861.40 on your mortgage. Not very desirable.

It gets worse. After 5 years they 'recast' or re-calculate your loan to enable you to pay off your loan in the remaining 25 years. If you have been paying the lowest payment, your payment could rise significantly.

The popularity of these loans comes from the fact that it gives you the ability to afford a home when prices have increased so rapidly. As long as you don't focus on payment Option 1 and keep in mind you really owe the higher payment you can keep yourself from any unwanted surprises.

For more information, please contact us.
posted by Pac Res @ 11:37 AM  
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