Consumers’ appetite for low payment mortgage programs continues to be strong. Exacerbating the demand for low payment mortgages has been skyrocketing home values. Home prices have risen considerably during the past few years. As you can imagine despite historically low interest rates, housing has become less affordable. To counter this problem many lenders offer Option ARM’s.
The recent sub-prime meltdown has forced a lot of lenders to scale back on their aggressive pick a pay programs. However, the option ARM is still around. In fact I was just asked by a borrower today for details on our Option ARM.
A major reason for its popularity is that Option ARMs allow for multiple payment plans. Typically, the borrower will receive a monthly statement that outlines the current interest rate and loan balance. It will also show four different payments based upon different criteria.
The first payment option is typically the “minimum payment” which is calculated based upon some pre-determined criteria. The minimum payment is usually less than the interest charged for the month, resulting in “negative amortization,” or the more politically correct term, “deferred interest.” It’s very important to understand that making payments with negative amortization results in a rise in loan balance, to cover the interest not paid.
The second option is usually the “interest only” payment, which is equal to he interest charge for that month – the loan balance stays the same. The third and fourth options carry a 15 and 30 year amortization. The payments are higher, but the principal balance is curtailed every month.
As with any loan product the Option ARM needs to be closely examined to determine if it’s right for you. You need to understand the index the ARM is tied to because you rate will change with this index. While a low payment is attractive potential high payments down the line is a very real possibility.
My personal view is that the Option ARM is a tool that you can use to get yourself out of a tight financial situation or to solve a short-term problem. However, if you have long term plans for your property or, if you have no reason to put off mortgage payments then this is not for you. This is certainly not a product to get into a bigger house than what you can afford. You need to be aware that despite all the fancy options, at the end of the day the lender will expect you to pay back the money they’ve lent you!