Ask the Experts: What is an option ARM?
An adjustable rate mortgage (ARM) that offers different payment choices each month is called an option ARM. Each month, you select the payment option appropriate for your budget.
Option ARM payment choices usually include:
Minimum payments—These payments cover only a portion of the interest due for the month, resulting in unpaid interest that’s added to the unreduced principal balance you owe.
Interest-only payments—These payments cover all interest due for the month, but don’t reduce the principal balance.
Fully amortizing 30-year payments—These payments reduce both interest and principal on a regular amortization schedule.
Fully amortizing 15-year payments—These payments accelerate total loan repayment and result in faster equity buildup and overall interest savings.
Option ARMs appeal to people with fluctuating income (the self-employed, commissioned workers, or those who experience seasonal income variations) because they can pick the monthly payment best suited to their cash flow. However, given the flexible payment options and their liberal qualifying ratios, these mortgages are also sought by people who want to buy more house than they can otherwise afford.
Borrowers should be aware that consistently making minimum monthly payments will cause their mortgage balances to increase. These increases in turn will cause the borrower’s loan to be refigured periodically; as a result, the minimum monthly payment amount will then increase, perhaps substantially.
As with any financial decision, carefully weigh both the risks and benefits before accepting an option ARM.