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About Option ARM
If you are looking to buy a new home or refinance your existing mortgage, you have many types of mortgage loans that you can choose from.
One such mortgage loan is an option adjustable-rate mortgage. In this post, we will learn everything about option ARM in detail.
What Is An Option ARM?
An Option adjustable-rate mortgage, also known as flexible payment ARM is a type of adjustable-rate mortgage loan that allows the borrower to choose from several options for the type of payment the borrower will make.
ARM Options In addition to having the option to pay interest and principal equal to conventional loans, other payment options allow the borrower to pay interest only or pay less with lower payments.
Some payment options in this type of option mortgage do not pay the full amount required to repay the mortgage.
Below mentioned are the payment options provided in an option loan.
- You pay an amount that includes both principal and interest. This is one of the best options to ensure that you reduce your principal amount every month and pay off your mortgage.
- Option to pay interest only. If you only pay interest, the principal or loan amount will not be reduced as you don’t make any payment towards your principal amount.
- Option to pay minimum or limited payments that are lower than your interest amount. The unpaid interest amount is added to the principal and thus increases the loan amount that you owe.
How Does Option ARM Work?
Generally, the option ARM mortgage has a considerably lower interest rate for the initial few months.
Initially, you might be paying one or two percent on the loan before the interest rate starts to adjust according to the market.
The monthly payment paid by the borrower for the first year depends on the initial rate of the loan.
If the borrower chooses the limited payment option, the unpaid interest gets added to the loan balance which increases the total loan amount you owe to the lender.
This process is also known as negative amortization. This means that your loan balance keeps increasing even after you make the minimum payments as these payments are insufficient to cover the interest amount.
Due to the negative amortization, the property could end up being underwater, which means that you owe more than what your property is worth.
Generally, there is a cap for your payment increase every year in this type of mortgage.
Your mortgage payments are recalibrated every five years depending on the years left on your original loan term.
What Are The Pros And Cons Of Option ARM?
Just like every other loan, option loans have their advantages and drawbacks.
Pros:
ARM options offer lower interest rates and prepayments compared to traditional long-term loans.
Borrowers who choose the ARM option can also take advantage of a market downturn without having to refinance.
Option arm mortgage could also benefit real estate investors who are looking to sell the property in near future.
Cons:
The initial payment in an option mortgage is small, but as the term progresses, the payments may increase over time.
The reason for an increase in payments could be due to the end of the initial option that the borrower chooses or could be due to an interest rate hike in the market.
If the borrower chooses the limited payment option without a proper repayment plan, the loan could enter into negative amortization and may face challenges to pay off the loan.
Conclusion
The option arm loan may be one of the excellent options for borrowers who are looking to take advantage of the low-interest rate for short period.
However, it is important what kind of payment option you choose.
Planning your payments before entering into such types of commitments can help you to avoid any financial pitfalls in the future.
