Beware of the loan that offers a helping hand or in this case “ARM”, these loans look initially attractive and come with a variety of possible burdens.
An option ARM is a loan that adjusts the interest rate monthly, the payments annually and “allows” the borrower to choose the amount of the payment. Sounds great right? WRONG! Although the initial benefits are obvious there are some turns in the road that can not been immediately seen. Since the borrower can choose two types of payments “Interest only” or “Minimum Payments” there is a possibility of negative amortization.
What is negative amortization you ask? It is when even though payments are made the principal balance of the loan continues to grow. How can you spot an option ARM? Asking your lender, if the loan can be negatively amortized and how often the interest rates adjust are two very good indicators. These loans are attractive because they offer the opportunity for the borrower to initially purchase “More House” for less money, providing the borrower with the opportunity to invest and save the monies not spent in the first year. The challenge with this loan is that it does not guarantee security from risk in later years.
Option ARM loans could be considered the Shock and Awe of mortgages. The possible pitfalls with this loan are that the payments can rise dramatically because every five to ten years the loan has to be recast. This can mean an increase of major proportion that the borrower was not prepared for. In addition the loan balance has a negative amortization maximum. Based on interest rates this could happen even before the five year recasting and could increase the actual loan balance to 110% - 125% of the original loan with out regard to the increase in payments.
There are ways to protect yourself if you choose and option arm. Initially instead of taking the lowest payment option in the first year, make the maximum payment you can afford. By making the initial payment high you will decrease the shock from payment changes in the future.
Option ARM allow for more house in the immediate and higher payments in the future. This loan may be for you if you are expecting a dramatic increase in future income. There is usually a refinance option should income levels not meet your expectations, but be careful because the only other choice is default if the payments are not met.
As with any major purchase the key is education and research. Shop around, do your homework and consider not only your immediate wants but your potential for your future income to meet the needs of the loan. By preparing for the future, and properly evaluating your future your home will not cost you and ARM and a leg.