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Ryan’s Mortgage Blog:
Beware of the Option ARM. These mortgages can get you in trouble pretty fast if you don’t pay attention. An Option ARM is an adjustable rate mortgage that typically has 4 payment options. Option ARMs became popular within the last couple of years, and lenders have recently created similar programs by changing a couple of the “options” or terms. So for the sake of this blog, I will be referring to the typical Option ARM. You can pay the min. payment, which is below the interest only rate (negative amortization), so your loan balance goes up if you make this payment. The 2nd option is an interest only payment (no amortization). The 3rd and 4th options are 15 or 30 year amortizing payments, which are fully amortizing. Usually your min. payment will stay the same for the first 12 months and adjusts annually there after.

Having 4 payment options a month can be nice, plus the minimum payment may be so attractive you end up opting to buy the bigger, more expensive house. These loans were designed for people who have variable income from month to month (i.e. sales person, small business owner, etc.). For example, one month you didn’t do good selling luggage and you opted to make the minimum payment which was only $1,500. The next month airline tickets dropped and luggage sales went through the roof so you opted for the 30 year amortizing payment of $3,000.

From what I have read, some people claim these loans were also designed for people who plan on selling their home fast (within a year or two), but I beg to differ. Many Option ARMs I have seen come with a pre-pay penalty, which wouldn’t make sense if you sold soon. You can get ones without pre-pay penalties, but it may cost you a little more in closing costs or in your rate. There are better programs available if your only concern is selling soon (3 or 5 year I/O ARMs just to name a couple).

I’d say nearly 75% of my clients that I refinance OUT of an Option ARM tell me their broker did not tell them all the facts about the loan and they felt tricked. If a broker is trying to talk you into an Option ARM, this should raise a red flag…unless you trust them completely. I would proceed with caution. Make sure they explain everything to you as well as offer you other programs. One thing some brokers “forget” to “remind” you is the interest rate is adjusting monthly. It is called an “Adjustable Rate Mortgage” for a reason. Even though your min. payment stays the same, your interest rate may be rising without you even noticing. Over the last year I have seen mortgage statements from clients where their rates increased monthly for nearly the whole year. Another problem with these programs is the rates are usually higher than the standard ARMs or fixed mortgages. Many times this is because of the margin, which is the rate that is added to the index to determine your interest rate. I have seen margins on the Option ARMS as high as 4.5, so even when the index is low and everyone else is getting good rates, your rate would be around 9.5%. Although I didn’t research the stats, I would assume rates are higher on these mortgages because borrowers tend to default more on these programs because of the negative amortization and adjusting rates. Also note, the lender will only let you pay the minimum option for a certain amount of time, otherwise you’d be digging too great of a hole in built up principle and interest.

A big problem is when you pay the min. payment your loan balance increases (neg. am.). I have seen cases where people made the min. payment for several months and before they knew it they were upside down in their new home because the value of their home depreciated, while their loan balance increased. This is obviously not a good scenario.

Don’t get me wrong these programs may be a good choice for certain people, but be VERY CAREFUL if you are thinking about one for yourself. I suggest looking into the HYBRID ARM, which is a cousin of the Option ARM. The main difference is you can get the interest rate fixed for a certain number of years, but you still have the payment options.

Many brokers may get upset with me telling you all this stuff, but as you will see, I only want what is best for my clients and that includes only offering them the truth. This is the most deceiving loan out there, and to be honest I do not recommend it to clients unless it fits their situation and they completely understand it. Every client is unique, so I don’t have a particular loan program I offer them or try to push on them…I first listen to what they want/need, and give them options based on their needs. If you have any mortgage related questions, feel free to ask me! Just so you know, we do mortgages in 48 states. My number is 805-540-0866 and my email is Ryan@GoMetroLoan.com

PS – If you are currently in an Option ARM feel free to contact me and I can help you figure out if there is anything better out there that would save you money. This is all free with no obligations…no tricks 🙂

Written by Keith Byrd - Go to Keith's Website/Profile