Questions and Answers About Option ARMs. What are Options ARMS? How Do They Work?
Meaning of Option ARM's: Option ARM is an adjustable rate mortgage where the borrower has several options in making the monthly payments and thus offer him a great flexibility. The rate in this mortgage adjusts monthly based on the index added to the margin rate. In addition to having the choice of making payments of interest and principal made in the conventional mortgages, option ARM provides alternative payment options where the borrowers can make significantly smaller payments by making interest only payments or minimum payments. Options ARMs are recomputed every five years and contain a variety of rate adjustments which depends whether the indexes move up or down. The flexibility is the main attraction of option ARMs but it is advisable to the borrowers to choose wisely among its various options.
How option ARM works
Unlike the traditional mortgage that has fixed monthly payments, option ARM's provides borrower several payment options to choose from. They have complex structure and thus making them hard to understand. Option ARMs have complex structures, making them hard to understand by borrowers. Just don't go for option ARMs unless lender explained you risks associate with it under various scenarios. Ask them questions like what would happen if rates rise rapidly and steadily for several years, or what would happen if rate falls. One of the main reasons of their popularity is the choice of an extra low minimum payment that makes it possible to finance a house if you have relatively little money. But do remember the minimum payment options leave borrowers deeper in debt with each payment.
The working of option ARM's include
Adjustable rates: With the traditional mortgages the interest rate is fixed and thus your monthly payment remains the same for the entire length of the loan. On the other hand with option ARM the interest rate goes up and down and thus your payments also goes up and down. The main attraction of this loan is that it starts with a very low teaser rate which later rises to the market based rate.
Provide multiple options: In a typical option ARM you have various payment choices. The first one is the regular mortgage payment that includes both interest and principal and thus keeps you on a track to pay back the loan in 30 year schedule. The second option is just like the first one but with it you pay off the loan in 15 year schedule. It include greater amount of principal. Third option is interest only where you pay only the interest that has accrued on the loan over the past month. As you are paying only the interest, you just don't get closer to having the loan paid off.
You can go with minimum payments: On most option ARM's the minimum payment cannot be increased by more than 7.5% per year. The cap is lifted after five years when the loan is recast. Minimum monthly payments can touch the sky if the loan balance hits a negative amortization cap of 110 to 125% of the original loan amount. The unpaid interest then gets added to the principal of loan and thus leads you in greater debt and thus is termed as negative amortization.