All About Option ARMs!

There's a type of home loan that's sweeping the mortgage industry right now, yet many homeowners and real estate professionals have not yet heard about it. Always being on the cutting edge of mortgage products, I have a working relationship with the only lenders in the country that currently offer this unique home mortgage product!

This special type of mortgage is called different names by different lenders, but the basic concept is the same and the features are similar, just slightly different characteristics and/or qualifying requirements depending upon which lender you select.  It's called either a Pick-A-Pay, Cash Flow, Flex, or Option ARM (which means Adjustable Rate Mortgage).  The most unique benefit of having this type of loan is that it gives you, the homeowner, control over your mortgage, instead of your mortgage having control over you!  That's basically it in a nutshell.  One of the unique features is that the amount of your monthly mortgage payment is flexible each and every single month, so that you are free to choose whichever payment option best suits your overall household budget for that particular month!

Below is a brief question-and-answer session I have personally authored in which I attempt to answer many of the same questions I had about this product when I first heard about it myself, and explain as many details as possible to you so that you may fully understand it.  You will probably have many of the same questions I did.  Frankly, I would expect you to, and that's what this section is all about.  I hope to have already answered most questions that might immediately come to your mind, but if you don't see your question answered here below, please do not hesitate to email me and ask!  I'll answer your question and add it to the list here, as I continue to refine this section often, and I'll continue to add new information until every possible issue has been addressed. This may all seem kind of complicated, but it's really not, and it's worth taking the time to understand.  Please read carefully, and remember to let me know if you have any additional questions! 

*** The following information is the sole responsibility of the author of this document and subject to change without further notice

Questions and Answers About Option ARMs: 

1. Q.) What does the name of this loan really mean? 

A.) Pick-A-Pay means "pick a payment", in that you, the homeowner, have your choice of "picking" which payment to make on your home mortgage each and every month, depending on that month's particular household budget.  Cash Flow means that this type of loan can generate extra monthly "cash flow" for you to more easily manage your finances, by enabling you to make the low minimum payment option any month you choose.  Flex means that the product is flexible, and Option just means that this loan gives you, the borrower, the "option" of which payment you would like to make for any given month.  Each mortgage product under these different names is basically the same concept and same type of loan, with a few minor differences in certain areas depending on the lender, such as qualifying requirements, acceptable loan-to-value (LTV) ratios, and interest rate parameters.

2. Q.) What makes this loan so special, compared to all of the other mortgage loans available today?

A.)  This loan is unique for several reasons, primarily because it combines the best features of both a variable interest rate and a fixed interest rate loan, each and every month, which allows the borrower to choose between which type of payment to make on a monthly basis.  Up until recently, when borrowers purchased or refinanced their home, they basically had their choice of either a fixed interest rate or an adjustable interest rate mortgage and that was it, unless they refinanced into a different type of loan later on.  There is usually no flexibility in your monthly payment amount when the payment comes due - you either have it or you don't.  Isn't that the way your current home loan is structured?  Are your current monthly house payments flexible?  Do you have a choice of paying a different amount on any given month if you want, and still be considered fully paid for that month?  Probably not!  The Option Arm gives you a choice of which payment to make each and every month, based upon a variable interest rate, and on different loan amortization terms, and this is all possible within the same loan, every month!  You don't have to refinance to change your monthly payment amount - you can pay the minimum amount due when cash is low, and increase your payment when your budget will allow.  It all comes down to giving you, the homeowner, flexibility over your monthly  mortgage payment, to help you better manage your ongoing monthly expenses and the financial needs of your household's budget. 

3. Q.) How many different payment choices are there each month, and what are they?

A.) With each lender, there are typically four different payment options to choose from every month - the first is a bare minimum monthly payment based on an introductory interest rate of anywhere from 1.00% to 1.95%, which is determined by which lender you have selected and the loan-to-value ("LTV") of your home based upon the appraisal done at the time the loan is approved.  The second payment option is an interest-only payment that is based on simple interest only (rate times principal balance divided by twelve).  The third payment option is a fully-amortized payment based on a 30-year amortization schedule.  Finally, the fourth payment option is a fully-amortized payment based on a 15-year amortization schedule (which will naturally be the highest dollar amount, since the shorter the loan term, the higher the monthly payment).  All four of these options are available for you to choose from each and every month your payment is due, except for under one condition:  If current interest rates have fallen to the point where the simple interest payment would be less than the minimum monthly payment for that month, then you will not have the simple interest-only payment option for that month.  There will be only three payment choices instead of four for that month, and every month thereafter in which this is the case.  The reason is because you can never make less than the minimum monthly payment for any given month.( Additionally, to avoid the possibility of creating “Negative Amortization” or Deferred Interest”, if the index increases incrementally to the point where you see an “Interest Only” payment on your monthly invoice you should treat the “Interest Only” payment as if it were the “Minimum Monthly Payment”. This prevents the possibility of developing any negative amortization.)

4. Q.) What is the main reason a homeowner should consider this type of loan over a traditional fixed interest rate or adjustable interest rate mortgage?

A.) Because of its sheer flexibility and savings potential on a monthly basis!  Having this type of mortgage can free up cash for other expenses, allow you to have more control over your monthly finances, and also gives you the potential of saving thousands of dollars in interest charges over the life of the loan.  With recent job losses and bankruptcy filings at a record high, many homeowners could have possibly prevented the loss of their home in foreclosure, if they would have had an Option ARM!  When your house payment is set at a pre-determined amount, you either have it at the beginning of every month, or you don't.  Well, what about when something unexpected comes up and you are a little short that month?  If there is no flexibility in your house payment, something else will have to be cut from your budget.  But, what if instead of having to meet that fixed $3,000 house payment each and every month, you had a choice of paying for example, only $1,100, and your house payment would be considered as paid in full for that month, and you had this flexibility until your short-term cash flow issue was resolved?  I think that would be a huge feeling of security and relief for many people.  This way you can plan your budget around your chosen mortgage payment for that month, instead of the other way around!  

5. Q.) What makes this type of loan possible?  It seems as though a loan like this would be difficult for a mortgage company to keep accurate track of, if I chose a different payment option every month.

A.) The simple answer to this question is because of the advancement of computers and technology.  Computers have evolved to the point that sophisticated loan amortization programs have been written with the ability to handle multiple payment options within the same loan, instead of a traditional adjustable or fixed interest rate only.  I seriously doubt that this type of loan would be available if new software had not been written and developed for the mortgage industry to be able to offer this type of product. 

6. Q.) If I choose an Option ARM mortgage, will I be able to see exactly how my payments are being applied each month?  I would not be comfortable with just a payment book, if I was making different payment amounts each month and not knowing which amounts were being credited toward interest and principal.

A.) Yes, with the Option ARM mortgage you will actually receive a new statement from your mortgage lender each and every month, just like a utility bill, that details exactly how your previous month's payment was applied to your loan, shows you the amounts due for each of your three or four  upcoming payment options ,and  your remaining principal amount. You will have a snapshot of your loan each and every month, so that you will know exactly where you stand at any given point in time.  That's also a convenient feature, as many lenders provide statements only once a year for tax purposes, or once a quarter if your escrow amounts (for taxes and insurance) change.

7. Q.) Wait a minute - you mentioned "deferred interest".  What's that again?

A.) Deferred interest is any interest that may accumulate;  i.e. not get paid, if you choose to consistently make only the bare minimum monthly payment for several months, or years, in a row.  How this can happen is if interest rates are steadily going up but the dollar amount of your payment is not, if you are continuing to make only the minimum monthly payment month after month.  Under this scenario, at some point you may find yourself in the situation of being behind in the total amount of interest that would normally be due at that time, for the reason that the minimum monthly payment dollar amount is fixed, but the underlying interest rate is not.  Any interest that has accumulated in this manner is called deferred interest, because it has been deferred, or charged to the account, but not yet paid.  In this case, you are not paying all of the interest due at that time because the underlying interest rate has changed, but the dollar amount of your payment amount has not, and therefore interest is accumulating faster than the minimum payments can pay it off.  No other type of home mortgage loan allows you to accumulate any deferred interest, and this can be a benefit.  You'll always know each and every month if you have accumulated any deferred interest according to your statement, and you can choose to pay any amount of it off at any point in time without penalty. Remember, if the “Interest Only” payment option appears on your monthly invoice, and you do not wish to create deferred interest,  you need to treat it as if it were the “Minimum Monthly Payment.” . By doing this you do not allow the development of Deferred Interest or Negative Amortization.(There are positives in deferred interest; in the IRS’s eyes, deferred interest is fully tax-deductible on your tax return. Also, the home’s  appreciation, based on current trends, usually outpaces the deferred interest increases to your mortgage balance over time.)

8. Q.) It seems as though it would be a disadvantage to accumulate deferred interest, wouldn't it?

A.) It would over the long term, because by repeatedly making only the minimum monthly payment, at some point you may find yourself in a situation known as negative amortization.  This situation may occur when your loan's principal balance is actually increasing, not decreasing, because you have not been paying even the minimum amount of interest due every month.  But that's ok.  The minimum payment amount is really meant to be a safety net and a security feature, not a payment that you would normally and regularly make every month all the time.  You could choose to make only the minimum payment every month, but if you were not investing or using the difference you were saving on your house payment in some other manner to generate a greater return than the interest rate you were being charged, then that does not serve the true purpose of this type of loan.  I personally recommend that people take out this type of loan with the primary intention of making the highest payment amount possible every month;  i.e. the 15-year fully amortized payment, whenever they can, and save the minimum monthly payment feature for when they really need it, so that they end up paying their principal down dramatically and saving thousands in interest charges, and also avoiding any possibility of negative amortization.

9. Q.) What is the starting interest rate of this type of loan based on?

A.) The bare minimum monthly payment option, or the first payment option listed on your mortgage statement every month, is based on an introductory interest rate of between 1.00%  or 1.95  depending on which lender you have chosen and other variables such as the LTV (loan-to-value ratio) of your home at the time the loan is obtained.  The minimum payment is a principal and interest payment fully amortized over a 30 year schedule, meaning that even though this is a minimum payment, it is not just interest only;  there is some principal repayment included in the minimum monthly amount.  After the first year, the dollar amount of the following year's minimum monthly payment is guaranteed not to increase more than 7.5% of the dollar amount of the previous year's minimum monthly payment, for each of the following four years.  So you will know going into this loan, even though it is based on an adjustable interest rate, exactly what the dollar amount of your minimum monthly payments will be for the first five years of the loan.  The underlying interest rate may adjust during this time, but the dollar amount of the minimum monthly payment will not.  This is an important distinction to keep in mind. 

10. Q.) Can you give me an example of this?

A.)  Certainly.  In your attached example, an 80% first mortgage, for a principal loan amount of $320,000, if your introductory interest rate, meaning the interest rate your first year's payment was based on, was 1.05%, your minimum monthly payment for the first year (principal and interest only, not including taxes and insurance), calculates to be $1,029..  The following year, your minimum monthly payment could only increase by a maximum of 7.5% of the previous year's minimum dollar amount, which in this example would be $77.  So in this example, the following year's minimum monthly payment option could increase to no more than $1,106.  This amount then becomes the minimum monthly payment for the second year, and the third year could increase by no more than 7.5% of the dollar amount of the second year, and so on, for the first five years.

11. Q.) So I will always have a guaranteed minimum payment amount every month as a "safety net", that will not increase in dollar amount by more than 7.5% of the previous year's minimum payment amount, for the first five years of the loan?

A.) Yes, that is correct.

12. Q.)  What effect does this dollar amount increase have on the underlying interest rate of the minimum monthly payment?

A.) It has the effect of raising the underlying interest rate of your minimum monthly payment by approximately one-half of one percentage point for the following year.  In other words, if your starting interest rate is 1.00%, and your minimum monthly payment amount increases by the maximum of 7.5% for the second year, that will have the effect of increasing your underlying interest rate to approximately 2.49% for the second year, and so on, for each of the remaining three years of the fixed payment option, if the minimum monthly payment increases by the maximum of 7.5% after any given year in the first five years.  Remember, the minimum payment amount doesn't have to increase by that much - it doesn't have to increase at all, and it may not.  If it does increase, the increase is limited to 7.5% of the dollar amount of the previous year's minimum monthly payment. 

13. Q.)  How is the interest rate of the other three payments determined for any month?

A.) The effective interest rate of the other three payment options is a variable interest rate that is calculated by adding what is known as the index, which is typically a  quantity known to the general public that you can easily follow on a regular basis, such as the current interest rate of the one-month United States Treasury Bill, the Cost of Savings Index (COSI), the Cost of CD Deposits (CODI) Index, or the Monthly Treasury Average (MTA), which are proprietary indexes based on a 12-month rolling average of current interest rates of either savings deposits, 3-month CDs, or US Treasury Bills.  In other words, you could follow your index by watching the current interest rates of the underlying instrument your index is based on, whichever it may be.  The index is then added to what is called the margin, which a fixed amount that the lender has already pre-determined at the time of the loan, to add to its index.  The margin amount stays fixed for the entire life of the loan.  Both the index and the margin that each lender uses may be different amounts by themselves, but added together they all average out to be about the same total.  The index plus the margin is called your fully indexed interest rate.  Some indexes are a little more stable than others, so some lenders prefer to use one index over another.  They all move in the same general direction, so if one index goes up they'll all go up, and likewise if one goes down.  In your example, the MTA index is at 1.677. The  margin associated with this particular lender is 2.650%, so the index plus the margin in this case would be 4.327%. This would be  the fully indexed rate that your second, third, and fourth payment options (the simple interest payment option and the two fully amortized payment options) of the Option ARM would be based upon, for that particular lender.

14. Q.)  Using the previous example, what would the dollar amount of the other three monthly payment options be then?

A.) Using a initial loan amount of $320,000 as in the example of Question No. 10 above, payment option number two would be simple interest only, calculated by ($320,000 x 4.327%) divided by 12, which for this example would be approximately $1,154.  Remember that the interest rate for all payments except the minimum payment option is calculated by using the fully indexed rate, which in this case is 4.327% (1.677  index plus 2.65% margin).   Payment option number three would be based on a 30-year fully amortized schedule at the fully indexed rate of 4.327%, which calculates to be $1,589, and payment option number four would be based on a 15-year fully amortized schedule at the fully indexed rate, which calculates to be $2,420. 

15. Q.) That's a pretty wide choice of payments!  So the minimum payment amount would actually be less than half of the 15-year fully amortized payment amount, all under the same loan?

A.) Exactly!  That's one of the great features of this type of mortgage.  In this case, you would have an extra $1,391 more dollars of "cash flow" for every month you made only the minimum payment, if something came up that prevented you from making any one of the other payment options, or if you were choosing to invest the savings difference at a return greater than the cost of the money.

16. Q.) So, the interest rate on the other three monthly payment options is based upon the index plus the margin, and can change every month depending on the what the underlying index of my loan is at that time?

A.) Yes, that is correct.  And also remember that payment option number three is based upon simple interest only, not compound interest.  This means you are not paying interest upon interest, so to speak.  The payment amount for the simple interest-only option for that month is determined by taking the remaining principal amount of your loan, multiplying it by your fully indexed rate (the index plus the margin), and dividing the result by twelve, to take into account the twelve months of the year.

17. Q.) Is there a lifetime cap on how high the fully indexed rate can go on this loan?

A.)  Yes, and the lifetime interest rate cap differs depending upon the particular lender you select.  The lifetime rate cap for the Option ARM has a current range of 8.95% to 10.55% depending upon the lender, but there should be no serious concern that interest rates will ever make a jump of that magnitude overnight, for several reasons.  Even when the Federal Reserve Board meets to discuss the direction of current interest rates, as it does eight times a year, if and when they decide to adjust interest rates, the incremental movements are always small -- usually no more than one-quarter of one percentage point (25 basis points) at a time.  I personally have seen the Federal Reserve raise interest rates more than one-quarter of a point only once in the past several years, when rates were raised by one-half of a point (50 basis points) in early 2000.  In addition, many mortgage indexes are calculated based upon a moving, or rolling, 12-month average of the underlying rate.  This means that the index is "smoothed out" by using the average of the last twelve months of this rate, not just last month's rate alone, to calculate the current value of the index.  This allows for monthly fluctuations in current rates without significant jumps in the value of the underlying index. 

18. Q.) Can I convert this loan to a fixed interest rate loan at any point in time?

A.)  Yes, a conversion feature may be offered on your Option ARM loan depending upon the lender you choose.  The lender I prefer most does offer a conversion feature, which allows the borrower to convert this loan to a fixed interest rate at any given time, for payment of a small $200 fee.  This is another safety aspect of the Option ARM, which may provide some comfort those who fear a sharp rise in interest rates sometime in the future.   We constantly monitor interest rates as a part of this business, and if we see an upward trend start to develop, we will suggest either converting the Option ARM into a fixed interest rate loan at that time or refinancing completely, long before your variable rate would ever reach the interest rate cap of the loan. 

19. Q.) Is there any pre-payment penalty associated with this type of loan?  In other words, will I have to pay a percentage of the outstanding loan amount as a "penalty" if I ever pay this loan off early by selling my home?

A.)  Any pre-payment penalty, if there is one, depends upon the lender and which loan program the borrower has chosen.   Pre-payment penalties can range from none to three years, usually offered in choices of no penalty, one year, or three years, with the fully indexed rate decreasing for those that select the maximum (three year) pre-payment penalty option at the time the loan is approved.  The lender does not particularly want the loan to be paid off early, so they will charge a little higher interest rate for that privilege.  If you know going in that you definitely plan on living in your home for at least the next three years, the question of pre-payment penalty would not even be an issue.  On the other hand, if you felt that there was no possibility of a job transfer within one year but possibly later, you might select the one year pre-payment penalty option, knowing that you probably wouldn't have to move within the year.   Some lenders will waive any pre-payment penalty as long as the borrower obtains a new loan from the same lender at the same or greater dollar amount after the Option ARM is paid off.  This is called a soft pre-pay.  Since housing is a necessity, this is almost the same as no pre-payment penalty, if you choose to move up and pay one loan off with the proceeds from another.  In other words, an unexpected job transfer doesn't necessarily mean that you would be obligated to pay a pre-payment penalty if you sold your current home - not if the loan you obtain for your new house is for the same or greater dollar amount and with the same lender.  And, chances are you will like this type of loan enough that you would probably take out the same kind of loan for your next home purchase, so that the possibility of any prepayment penalty is not really an issue.  Some lenders do have what is called a hard pre-payment penalty, which means that a pre-payment penalty is charged if the loan is paid off within the specified period of time, no matter what the circumstances. 

20. Q.) What kind of credit rating or credit scores are required to qualify for a loan like this?

A.) This is another criteria that just depends upon the lender.  In today's environment, lending decisions are becoming increasingly more and more credit-score driven, meaning that the lender will automatically qualify certain borrowers for a certain type of loan if their credit score is good enough, with no further questions asked.  One current lender of the Option ARM requires a minimum credit score of 680, and the others' lending decisions are not specifically credit-score driven at this time.  The average consumer credit score across the nation is about 620, and the range of credit scores is theoretically from 300 to 900 (although I have personally never seen a score below 450, nor one above 850).  Anything above about 720  is considered top-shelf or A+ credit, and since the Option ARM loan is tailored to the more sophisticated borrower, above-average credit scores are usually necessary, and these borrowers usually have them.  A borrower with a lower credit score but significant asset reserves may still be able to obtain an Option ARM mortgage, depending upon the underwriters' ultimate lending decision.  You can request an "exception" on the loan application if there are special circumstances that have temporarily driven the borrower's credit score lower than would normally be indicated by income, assets, or other credit history.

21. Q.) What are the costs associated with obtaining this type of mortgage?  Are they any different than what a typical fixed or variable interest rate mortgage would cost, and how much of those costs must be paid out of pocket?

A.) That's a good question, because it allows me to make a couple of additional comments concerning "closing costs".  First of all, an Option ARM mortgage is no different than any other type of home mortgage loan with respect to closing costs.  There is nothing "special" added to the cost of an Option ARM mortgage compared to any type of mortgage you may be more familiar with.  That having been said, please be aware that lenders who offer loans with "no closing costs" are usually financing those costs into the amount of the loan somewhere else, that I can virtually guarantee you.  Nobody that I'm aware of originates, processes, or closes loans for "free".  That's not to say the lender can't choose to charge a lesser amount for any particular loan, but that amount won't be zero!  If it's not listed in one place on your closing statement it's usually in another.  Most costs associated with loan closings, particularly re-financings, are often financed back into the new loan amount as common practice.

22. Q.) What about PMI (Private Mortgage Insurance)?  Are there additional costs for PMI with this type of mortgage?

A.) This is another lender-driven decision.  Some lenders require it, some don't, some will allow PMI to be carried separately so that it can be removed from your mortgage once your equity exceeds 20%, and others offer the option of including it in the cost of the loan, in the form of a "bump", or slight increase, in the starting interest rate and/or margin.  It really depends on your starting LTV ("loan-to-value") ratio.  Generally an LTV over 89.9% (in this product type) requires some form of PMI;  this is to ensure that the lender will be able to recover 100% of its underlying loan amount should the borrow default and the property is forced to be sold at foreclosure auction for less than the full amount of the borrower's outstanding loan balance.

 23. Q.) What should every homeowner know about the advantages of an Option ARM compared to a regular fixed-rate mortgage?

A.) First of all, it is a nationally-proven statistic that the average homeowner stays in one particular house for only 5 to 7 years, and then either moves up, down, or out of the area.  That having been said, the smart homeowner will realize that the first five years of mortgage payments on a fixed-rate, 30-year loan consist of almost entirely front-end interest, and there are not any meaningful amounts paid toward reduction of your principal balance in those first five years or so.  Any profit made on the sale of your home within the first five years of your owning it is much more likely to have resulted from market appreciation, not because your loan balance has decreased by any significant amount, unless you are the exceptional individual that has regularly paid additional amounts towards principal on your monthly house payment.  For example, in the first year of repayment of a 30-year fixed-rate mortgage of $150,000 at an interest rate of 6.0%, your monthly payment (not including taxes and insurance) would be $899.33.  At the end of the first year you will have paid $10,791.96 in total mortgage payments, and $8,949.89 of that amount will have been for interest only.  Only $1,842.02 will have been applied towards reducing the actual balance of your loan.  This means that in this example, 83% of the first year of your house payments on a 30 year mortgage are all interest!  If your fixed interest rate was higher than 6%, an even greater percentage would be interest only.  Therefore, it is easy to see how most of a homeowner's monthly mortgage payment goes directly to the bank most of the time, since most home loans are paid off within the first 5 to 7 years of their life, then the borrowers move and the cycle starts all over again!  The homeowners buy their new house with another 30-year fixed-rate mortgage, and then move again within a few years.  I speak from experience - this has happened to me and my family personally, 3 times in a row now.  We lived in our first home for 7 years, and the type of loan was a 30-year fixed rate mortgage.  We lived in our second home for 5 years.  Type of loan?  30-year fixed rate mortgage.  We have lived in our third home now for 5 years this summer.  Type of loan?  You guessed it, - another 30-year fixed rate mortgage.  That means that the majority of our family's housing payments for the last 17 years have been primarily interest payments to the mortgage company.  No, we didn't know for sure that we would be moving each time, but we had a good idea we would move and we knew it would be sometime, and the national statistics were there.  The moral of the story is this:  If you know for sure you will be moving within the next three to five years or so, or at least the probability is high that you will, one of the most costly mistakes you can make in your entire financial life would be to take out a 30-year, fixed-rate mortgage for the time you were going to own that home.  If you do, you will be paying potentially thousands more dollars than you need to for the privilege of owning your home for that period of time.  That's another reason the Option ARM makes so much sense.  It encourages you to think of your monthly house payment as a flexible amount, so that you can use your mortgage as a tool for financial planning, instead of mechanically writing checks for the same amount month after month.

24. Q.) What are the downsides then, if any, of this type of loan ?

A.) A few potential disadvantages come to mind, but they are for the most part controllable by the homeowner, and traps that can be avoided once you are aware of them.  First of all, this type of loan is NOT for everybody, and minimum credit score requirements prevent every potential borrower from qualifying.  The Option ARM can save the disciplined homeowner thousands of dollars over the length of time they own their home, but the flexibility of this type of loan could prove to be a handicap for those borrowers who don't pay as much attention to their finances as they should.  I do NOT recommend this type of loan to anyone who is simply trying to squeeze into as much of a house as possible with no equity or no extra cash reserves now, nor any expected, anytime in the reasonably near future.  The key is not to enter into an Option ARM mortgage with the intention of only making the minimum payment each and every month, UNLESS you are disciplined enough to put the difference that you save on your house payment each month into an another investment account that will bring a higher rate of return than the cost of this money;  for example investing the difference in stock mutual funds that have an average return on investment of 8 to 10% annually.  This will accomplish building a nice nest egg for you outside of any other retirement plan, using funds that would normally be spent paying interest on a fixed-rate mortgage.  If you don't have the discipline to save and/or invest this difference, then I would at least set an objective to make the highest dollar amount payment;  i.e. the 15-year amortized payment, every month possible, which will pay down your principal balance the quickest and at an interest rate that is below current fixed rates.  I would treat the minimum payment option as more of a safety net, to be used when necessary, but not on a regular basis, month after month.  The other downside could be a rapid rise in interest rates, which is a negligible risk that has already been addressed in Questions 18 above.

 25. Q.) What happens if we still have this loan after the first five years of the Option ARM have passed?

A.) The minimum payment and simple interest only payment options will go away after the end of the fifth year, leaving only the 15-year fully amortized and 30-year fully amortized payment options as the remaining monthly payment options.  But, these will continue to remain under a fully indexed variable interest rate, consisting of the index plus the margin, unless the loan is then converted to a fixed interest rate, provided that this option was selected at the time the loan was originally opened.  Chances are much more likely that the loan will have been paid off by the end of five years from the date it was originally taken out, as discussed in Question 22 above.

27. Q.) Is there a cap on how low the variable interest rate of an Option ARM can go?

A.) No, but since the underlying index cannot theoretically go to zero (that would be 0% interest on U.S. Treasury Bills and/or CDs, not a highly likely scenario!), and the margin is typically a fixed amount, the probability of going much lower from current levels is relatively low.  Also, if interest rates were to rise dramatically and the borrower did not convert to a fixed rate or refinance into another type of loan, there is no cap preventing the interest rate of the Option ARM from dropping back down and returning to its previous level or lower.  This is a good feature, because some mortgage loans have a cap on the downside, once rates have moved up.

Your home, while being the largest purchase many families will make in their entire lives, can, and should, be used as a tool to help you manage your family's finances, not be a trap that allows for no flexibility in the use of what will possibly be your biggest asset.  The Option ARM mortgage is a revolutionary home mortgage, as it allows you to do just that! 

Eligible Property Types:

Single Family Homes, 2 to 4 Family properties, Investment (Non Owner Occupied) Properties, Primary Residence and Second Homes!