Option Adjustable-Rate Mortgage (Option ARM)
Candlefocus EditorThe most common payment options an Option ARM borrower has are: 30-year, fully amortizing payment; 15-year, fully amortizing payment; interest-only payment, and a minimum payment. A 30-year fixed-rate mortgage, for example, requires you to pay back the loan for 30 years at the same rate of interest. With an adjustable-rate mortgage, your interest rate can change every few years. An Option ARM includes a flexible payment option that allows you to choose the amount you pay each month — a minimum payment, interest only payment or 15-year or 30-year fully amortizing payments.
The minimum payment option is the lowest possible payment. This generally covers only a portion of the interest due on the loan and won’t do anything to reduce the principal. This can result in the loan balance increasing over time and is the least advisable option. Furthermore, in most cases, if the minimum payment option is selected for a period of time, the lender may require the borrower to pay past due interest.
Alternatively, the 30-year and 15-year, fully amortizing payment options are the more traditional fixed-rate mortgages that you pay over a certain amount of time. An interest-only payment pays only the interest owed on the loan, but does not make any payments toward the principal.
In order to prevent a ballooning of the loan due to choosing too low of a payment, borrowers must use good judgment when deciding which repayment structure to employ. Additionally, because the monthly payment options and changes in the underlying interest rate can result in payments that do not fully amortize the loan, anOption ARM borrower must be especially cautious and prepared to keep up with payments. If borrowers are not careful and use an Option ARM to take on more loan than they can handle in a worst-case scenario, they will be confronted with substantially increasing debt and must find a way to stave off foreclosure.
In the end, it’s important for borrowers to carefully read the mortgage documents and understand the full range of payment options before signing the agreement. Although an Option ARM can offer some payment flexibility and the potential for lower monthly payments than a fixed-rate mortgage, borrowers should exercise extreme caution and be aware of the potential risks before they enter into anOption ARM agreement.