Much bad press has undeservedly been given to the most extraordinary mortgage loans ever offered to the homeowner. The option arm loan gives more flexibility and allows the borrower to act as their own arbitrage if they like.
I will explain the option arm loan generically. Different lenders have slightly different versions. Always review the loan program disclosure from the lender which details your particular loan.
The option arm guidelines give the borrower four choices of payments each month (there are really more, but we'll discuss that later). The four payment choices the borrower is given are as follows:
1.) a borrower may pay a minimum required payment.
2.) an interest only payment.
3.) a payment based on a fifteen year amortization.
4.) a payment based on a thirty year amortization.
Let's look at the payment options closer. Payment option 1.) a borrower may pay a minimum required payment. What is the minimum payment and what is it based on? First of all, you must purge your brain of any indexes or margins when calculating this minimum payment. Once your head is cleared of these preconceived notions, you may proceed. The minimum payment is based on an introductory rate. What is this rate based on? Marketing! What sounds good, 1%, 1.5%, 2.95%. That's right and it's not related to any index! This is a PAYMENT RATE. Your fully indexed rate will be higher. If you close on an option arm loan and you make this minimum payment, you will be deferring interest and increasing your principal balance. If you don't like the idea of adding to your principal balance, then you may like option 2.) an interest only payment.
2.) The interest only payment is just what it sounds like. You are paying nothing to the principal and you are only making payments satisfying the interest each month. If you feel guilty doing this, ask your accountant how much of a tax break uncle Sam gives you on your principal payments.
3.) 15 year amortization. Make this payment and loan will be paid off in 15 years. This payment amount will change so review your statement each month if you want to pay your loan off in 15 years.
4.) 30 year amortization. Make this payment and loan will be paid off in 30 years. This payment amount will change, so review your statement each month if you want to pay your loan off in 30 years.
The 2 most important payment options are payment option 1.) and payment option 2.).
A payment equalling or greater than payment option 1.) must be made monthly according to the note. If you want to pay your interest as you go, then payment option 2.) will achieve this goal and the principal balance will not increase due to interest deferrment.
The two least important payment options are payment option 3.) and payment option 4.). I believe these options were placed in the pay option as a marketing tool more than anything else. The reason being, in reality, if you satisfy payment option 1.), you can add any amount you wish to your payments to amortize your loan for whatever term you like ie: 22 years, 25 years, 14 years, etc.
Some important points regarding making payments to the principal of your loan.
1.) Building equity by paying down your principal is fruitless. The money you dump into your home on principal payments does nothing but sit there (and helps the banks investments and portfolio). Why not be your own arbitrage and invest this money and make it grow?
2.) Equity is a zero sum game of risk. Less equity means the lender has more risk and the borrower has less risk. More equity means the lender has less risk and the borrower has more risk. Who's risk are you more concerned about?
3.) Real estate almost always goes up in value over time. Your appreciation in value on your real estate has no relation whatsoever to the amount of principal payments you make on your mortgage. Your house will continue to appreciate over time whether you have a mortgage at 50% loan to value or 90% loan to value.
4.) If you take a coffee can and stuff $10,0000 into it and bury it in your back yard and dig it up 10 years from now, what will you have? $10,000.00 right? What if you take that same money and invest it in a conservative investment?
With that said, naturally I am a strong proponent of making payment option 1.) or payment option 2.) but no more than payment option 2.).
Let's take a quick look at option 1.) in the real world. Let's say you want to take out a $200,0000.00 mortgage loan. Your monthly payment with a 1% intro rate would only be $643.28 for the first year. A $300,000.00 mortgage loan would have a monthly payment of only $964.92 for the first year. After year one, the payment can only increase 7.5% of the payment amount. So in year two on the $200,000.00 mortgage your minimum payment would be $691.53 and on the $300,000.00 mortgage loan the year two minimum payment would be $1,037.29. The a.p.r. is 1.5% - 2.5%.
Bill Burress, Nationwide Mortgage Expert can help homeowners get approved for a purchase or refinance loan with no application fee. For information on any of your mortgage needs, You may contact Bill Burress, Nationwide Mortgage Expert at Toll Free 1-800-239-1416. or fill out the 30 Second Inquiry Form.
Bill Burress, Nationwide Mortgage Expert has over 27 years experience in the mortgage business.
Bill Burress is now approving real estate mortgage loans in the following states: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Utah, Vermont, Virginia, Washington, West Virginia, Wisconsin and Wyoming.
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