Pay - Option ARM

Pay - Option ARM

· Pay Option ARM is an Adjustable Rate Mortgage that has multiple payment plans from which the borrower may choose. Each of the options are very different and factors such as time and interest rate must be carefully considered when choosing the plan.
· Pay Option Arm payment Options are:
o Minimum Payment Option(which may be less than the amount of interest due that month and may not pay down any principal).
o Interest-Only Payment Option(which does not change the amount you owe on your mortgage).
o 15/30/40 Year Fully Amortized Payment Option (payment of both principal and interest and keep the loan on schedule for a 15/30/40 year period).
· The interest rate on a payment-option ARM is typically very low for the first few months. After that, the interest rate usually rises to a rate closer to that of other mortgage loans. Your payments during the first year are based on the initial low rate.
· When a borrower makes a Pay-Option ARM payment that is less than the accruing interest, that leads to "negative amortization"(means the unpaid portion of the accruing interest is added to the outstanding principal balance).
· Pay Option ARMs are best suited to sophisticated borrowers with growing incomes, particularly if their incomes fluctuate seasonally and they need the payment flexibility that such an ARM may provide. Sophisticated borrowers will carefully manage the level of negative amortization that they allow to accrue.
· Option ARM loans are available with an initial introductory period, usually of 1, 3 or 6 months, after which the interest rate may change.
· Pay Option ARM also called "pick-a-payment" or "option" ARMs.
· Pay Option ARM loans are available with an initial introductory period, usually of 1, 3 or 6 months, after which the interest rate may change.
o With 1-month option ARMs that have a 1-month introductory period, the first interest rate change occurs when the 1st monthly payment is due. Thereafter, the interest rate may change monthly.
o If you have a 1-month option ARM loan with a 3-month introductory period, the first interest rate change occurs when the 3rd monthly payment is due. Subsequent interest rate changes may occur each month thereafter.
· Advantages:
o The low initial payment entices some borrowers into buying more costly houses.
o Borrower can minimize monthly payment to pay off other debt
o Sophisticated borrowers can take advantage of future increases in income
o Borrower can offset income fluctuations.
· Disadvantage:
o A sudden and sharp increase in the payment.
o The negative amortization can result in serious payment shock.
o The loan balance cannot exceed a negative amortization maximum, which can range from 110% to 125% of the original loan balance.
· Example: Loan Amount is $200000, Initial Rate is 1.25%, Index is 0.463%, Margin is 2.75%, Fully Indexed Rate ( index + margin ) is 3.213% then
o Minimum Payment: $666.50
o Interest Only Payment: $535.50
o Fully Amortizing 30-Year Payment: $866.36
o Fully Amortizing 15-Year Payment: $1,401.74
o Fully Amortizing 40-Year Payment: $740.74