Learning about Option and Other ARMs

By Karen Lawson
Mortgage Credit Problems Columnist

Adjustable rate mortgages (ARMs) can provide a great way for first time or credit challenged homebuyers to qualify for a mortgage loan. Within the category of ARMs, there are many choices offered. Option ARMs offer the lowest payment but can result in your loan balance and payment increasing over time. Traditional ARM rates start low but increase fairly quickly. Hybrid ARMs start with higher rates than traditional 1-year ARMs, but the rates can remain fixed for 3, 5, 7, or 10 years. Choosing an ARM that works best for you depends on several factors:

 

• How long you plan to keep the home you're buying: If you're buying a starter home, or are otherwise planning to move within a few years, an ARM can provide low payments for the duration of your stay.

 

• Local real estate market conditions play an important role: If home values in the area where you want to buy are dicey, an Option ARM with a very low initial payment may not be the best choice. The initial payments don't cover the amount needed to pay principle and interest; you could easily find yourself owing more for your new home than it's worth. A traditional or hybrid ARM doesn't come with this pitfall and is probably a better choice.

 

• Affordability: If you have bad credit, you may not qualify for the best mortgage rates, and lenders may offer you an ARM loan with a lower introductory payment. These mortgages can be very risky if you have a small down payment, housing values are iffy, or you aren't confident in your ability to raise your credit score and refinance before the payment increases. Do you have savings in case of trouble? If you need a bad credit mortgage, can you risk the possibility of more credit problems or foreclosure? If you're not sure that you can manage your finances and refinance to a grade-A loan within 2 years, it might be smart to put off home ownership until you are.

 

Why Option ARMs Can Be Risky

Fitch Ratings estimates that $29 billion worth of ARMs are due to reset by the end of 2009. If most of these borrowers have chosen the minimum payment option, their homes could now be worth less than the amounts of their mortgage loans, and their mortgage payments could increase by as much as 65%, which does not include potential increases for hazard insurance, mortgage insurance, and property taxes.

 

Option ARMs typically provide payment choices including the aforementioned minimum option, an interest-only payment, a fully amortized payment (which means that your mortgage balance will decrease rather than increase as it does with minimum payment options), and an accelerated payment (amortized over 15 years).

 

These loans can be ideal for homeowners who need flexibility to make larger or smaller payments as their cash flow changes (such as seasonally employed or self-employed people) but are NOT for those who need to always make the minimum payment in order to afford the house. Talk to a trusted lender to learn about all your options.

 

Source:

Pick-a-Payment Loans Turn Poisonous

About the Author
Karen Lawson is a freelance writer with more than fifteen years of experience in mortgage banking. She holds an MA degree in English from the University of Nevada, Reno.

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