What is a Payment Option ARM?
What are Payment Option ARMs?
A payment option ARM is a kind of adjustable rate mortgage that provides a borrower with a variety of methods to pay off their loan each month. These include:
Interest-only monthly payments (for a temporary period)
Minimum, often negatively amortizing payments (also temporary)
15-year fully-amortizing payments
30 or 40-year fully-amortizing payments
At first, borrowers will be required to make a specific payment based on a temporary, starting interest rate. After a certain period, they can switch to any other of the payment options, including a minimum payment, which often doesn’t cover the interest of the loan. While that can help borrowers save cash at first, it can lead to a lot of deferred interest (and some serious headaches) down the line. Plus, those minimum payments usually increase each year, so what started as a tiny payment may quickly get a lot larger.
Payment Option ARMs Payments Can Often Increase Without Warning
Unlike many other kinds of home loans, payments on payment option ARMs can often increase suddenly. For example, if a borrower is taking advantage of negatively amortizing minimum payments, and they reach what’s called a negative amortization limit, their monthly payment could be “recast,” or suddenly recalculated, based on the increased size of your new principal.
Add that to the fact that many lenders have been known to give payment option ARMs to borrowers who couldn’t really afford them, and it soon becomes apparent why this home loan has become a nightmare for many borrowers.
Who Is the Ideal Borrower for a Payment Option ARM?
Payment option ARMs are very risky, and therefore aren’t really a great option for most ordinary homeowners. One exception could be experienced real estate speculators, who want to purchase the property for little money down and low monthly payments, and hope to resell, or “flip” the property when its value has risen significantly.