QandAs: Loans

What is an Option ARM?

Answer:
An option ARM loan is perfect for borrowers

who want a flexible monthly payment. Adjustable rate mortgages or ARMs feature interest rates that adjust monthly or annually. On a traditional adjustable rate mortgage, the monthly payment will increase or decrease with each adjustment. Option ARMs are similar to traditional ARMs. The only difference is that option ARM borrowers can choose their payment amount.

This option keeps monthly payments low and affordable. With each adjustment, borrowers may decide to make higher monthly payments, interest-only payments, or choose the minimum payment option.

Option ARMs are advantageous because they offer low monthly payments during the initial loan years. This benefits homebuyers who live in overpriced housing markets. Likewise, lower monthly payments allow buyers to qualify for more expensive homes. Like most unique loan options, option ARMs include several risks. For starters, borrowers who select the minimum payment option may face negative amortization, in which the loan balance continues to grow. In addition, many borrowers suffer payment shock when monthly payments on an option ARM eventually rises to a fully amortizing level. The best way to avoid negative amortization and payment shock with an option ARM is to choose the highest affordable initial payment.


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