Option ARM mortgage can be useful

Option ARM can also be dangerous if you aren’t careful

The mortgage lending market is one with a wide variety of products designed to help just about anyone purchase a house. There are almost as many loan products as there are consumers. While most people can get by with a fixed-rate or standard adjustable-rate loan, some people need something a bit more exotic. At the extreme end of the exotic category is the Option ARM, which is a home loan that can be useful if you have the right type of finances. Unfortunately, many people take out these loans for the wrong reasons, and the results can be unpleasant.

Also known as the Pick Your Payment loan, the Option ARM, unlike other loans, allows the borrower to elect to make one of four different payments each month. The four types are:

• Minimum payment - This minimum amount is based upon an introductory “teaser” interest rate that is often only 1-2%. Paying this amount does not reduce the loan principal and does not ever cover the interest that has accrued during the month. Paying the minimum amount will actually cause the total amount the borrower owes to increase after the payment is made.
• Interest only - This payment covers the interest that has accrued during the month but does not apply anything to the loan principal. Paying this amount will allow the buyer to “tread water”, so to speak, but will not reduce the amount owed.
• 15 year amortization schedule - Paying this amount would, if paid every month, pay off the loan in fifteen years. This payment would consist of both interest and a small portion of loan principal.
• 30 year amortization schedule - Paying this amount would be the equivalent of making a payment on a 30 year loan. It will cover both principal and interest.

This type of loan was designed for, and works best with, people who have irregular incomes. Salesmen who work on commissions, freelance workers, seasonal workers, and those who get large annual bonuses. The Option ARM will allow the buyer to make small payments during the lean months of the year but make large payments during the times of the year when he or she has more money available to spend on a house payment. If you fall into this earning category and cannot make twelve regular, equal-sized payments, this type of loan will probably work well for you and would be a better choice than a fixed-rate mortgage, for instance.

The problem with this mortgage is that it is often offered to people for different reasons - the minimum payment is low. This may seem appealing to a twenty-something buyer in California who is suffering from sticker shock; the low minimum payment may make a house that is out of reach seem affordable. The problem with making the minimum payment over time is that the amount that you owe the lender will continue to increase and eventually the lender will demand that the loan be “recast.” You will, at that time, have refinancing forced upon you.

And when that happens, the loan payments will skyrocket.  For this reason, this loan is often called the World’s Most Dangerous Mortgage. But used in the right circumstances, it is a useful tool for buying a home.