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- Flexible payment ARM
Flexible payment ARM
- By Zitrof Real Estate
- Published 06/10/2009
- Real Estate Glossary - F
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A Flexible payment ARM is an adjustable rate mortgage on which the rate adjusts monthly with no adjustment caps, and that allows (but does not compel) borrowers to make very low initial mortgage payments that rise over time. Most commonly, they are referred to as "option ARMs".
Their major drawback is that those who select the minimum payment option may suffer "payment shock" – a sudden and sharp increase in the payment for which they are not prepared.
The main selling point of option ARMs is the low payment in the early years. This allows borrowers to buy more costly houses, or use the monthly payment savings to pay down other high-cost debt, make home improvements, invest in the stock market, and on and on.
Loan officers and Mortgage Brokers selling option ARMs have long lists of ways to use the Cash
Flow savings. They may provide little information about how they work and what the risks are.
The first is that every 5 or 10 years the payment must be "recast" to be fully amortizing. It is raised to the amount that will pay off the loan within the remaining term at the current Interest rate – regardless of how large an increase in payment is required.
The second exception is that the loan balance cannot exceed a negative Amortization maximum. After the first month, the minimum payment usually will not cover the interest due and the difference is added to the balance. All option ARMs have negative amortization maximums, which range from 110% to 125% of the original loan balance. If the balance hits the negative amortization maximum, the payment is immediately raised to the fully amortizing level.
Borrowers and lenders have no control over changes in the Interest rate index, but the margin and the interest rate in month one are set in the contract.
Their major drawback is that those who select the minimum payment option may suffer "payment shock" – a sudden and sharp increase in the payment for which they are not prepared.
The main selling point of option ARMs is the low payment in the early years. This allows borrowers to buy more costly houses, or use the monthly payment savings to pay down other high-cost debt, make home improvements, invest in the stock market, and on and on.
Loan officers and Mortgage Brokers selling option ARMs have long lists of ways to use the Cash
The first is that every 5 or 10 years the payment must be "recast" to be fully amortizing. It is raised to the amount that will pay off the loan within the remaining term at the current Interest rate – regardless of how large an increase in payment is required.
The second exception is that the loan balance cannot exceed a negative Amortization maximum. After the first month, the minimum payment usually will not cover the interest due and the difference is added to the balance. All option ARMs have negative amortization maximums, which range from 110% to 125% of the original loan balance. If the balance hits the negative amortization maximum, the payment is immediately raised to the fully amortizing level.
Borrowers and lenders have no control over changes in the Interest rate index, but the margin and the interest rate in month one are set in the contract.
