Understanding Option ARMs
More rates and news from
Yahoo Finance and Realty Times
By Melissa Wirkus
Choosing a mortgage
that best fits your specific financial plan as well as your personal
needs can be a very arduous task.
First off, there are so many mortgage products available on the
market that it can seem like an impossible task to figure out which
one will work the best for you.
The main thing you need to know is the two main types of mortgage
products; fixed-rate mortgages and adjustable-rate mortgages or
ARMs. The first one gives you a fixed interest rate throughout the
life of the loan which is generally 15 or 30 years.
ARMs are a bit more complicated and come in many different shapes
and sizes. But generally speaking, an ARM will give the borrower
a fixed interest rate for a certain amount of time, and then the
loan will “reset” to an interest rate that is congruent
with current market standards.
One of the types of ARMs that is gaining a lot of popularity recently,
and thus deserves some special attention is the Option ARM.
An October 23, 2006 article by Justin Pritchard of about.com, “How
option ARM loans
work (or don’t),” looks into the details and nuances
behind this non-traditional type of mortgage plan.
“You've heard about them under different names -- 1% loans,
pay-option loans, and more. Option ARM loans are mortgages that
give a borrower a choice on how much a given payment is. While their
flexibility makes them appear attractive, option ARM loans can be
quite dangerous. See how the ‘option’ and ‘ARM’
actually work to make an option ARM loan.”
These loans have been getting a bad rap lately due to people who
do not understand the loan and then mismanage it into default.
A borrower who takes out this type of loan needs to understand it
thoroughly. The lender must educate the borrower, and the borrower
must be open to retaining and understanding all of the details.
The best thing about this loan is that the borrower has choices
on how much they want to pay each month. So this loan is a particularly
good option for those with unsteady incomes or who work on commission.
“For example, your option ARM loan might allow you to make
any of the following payments: A low ‘minimum payment,’
a fully amortizing payment (for a 15, 30, or 40 year amortization
schedule, for example) or interest only. Based on your budget for
a given month, you pick the payment that you can afford.”
The most important things that people need to be aware of with this
loan is the fact that you could end up owing more at the end of
the loan that you originally began with.
“While the flexibility built in to option ARM loans is nice,
it comes with some risks. First, you don’t build equity unless
you make the bigger (amortizing) payments. Given a choice between
a large payment and a small payment, which one will you choose?
With the smaller payments, you’ll actually owe more on your
house at the end of the month than you did at the beginning.”
Understanding this fact in advance is the key to the Option ARM.
If handled responsibly and correctly, this mortgage is a great option
for many.
“If you must use an option ARM loan, make sure it makes sense.
These are best used by folks who just want flexibility, but who
are otherwise financially
secure. Don’t use an option ARM loan to get into a more expensive
home than you can afford.”
