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Something for the newbies (im one of them, lol) in the mortgage industry,
hope this helps:
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How Does an Option ARM Loan Work?
Option ARM (also called Pick A Payment or Pay Option ARM) loans work by
providing the borrower with four payment options each month.
Before we get into the payment options, let's review some of the important
terms and concepts involved with this loan program.
ARM - Adjustable Rate Mortgage. An ARM is a mortgage whose interest rate is
raised or lowered at periodic intervals according to the prevailing interest
rates in the market. Also called variable-rate mortgage.
Principle - The original amount of money provided in a loan is the
principle. This amount, plus the interest accrued must be paid back in full
by the end of the loan's term.
Interest - Interest is the cost paid to borrow the money.
Start Rate - The initial rate of the mortgage. This rate is the rate that
the "minimum" payment option is based on. Typically this rate will range
from 1-2%.
Amortization - The process of paying down the principle balance of a loan. A
fully amortized loan is a loan that will be paid off completely through the
monthly payments by the end of the loan's term.
Negative Amortization - Negative Amortization or "neg am" is the process of
adding unpaid interest to the principle balance of the loan. If you make a
"minimum payment," the difference between that payment and the interest only
payment will be added to the principal balance of your loan.
Index - An index is a measure of a particular security or other monetary
instrument that can be used to adjust interest rates. Index examples include
US Treasury Bond valuations, LIBOR (London Inter Bank Offering Rate), COFI
(Cost of Funds Index), and MTA (Monthly Treasury Average). Indexes can
adjust on a daily basis.
Margin - Margin is the difference between the Index and the rate on a loan.
Fully Indexed Rate - The fully indexed rate is calculated by adding the
Index to the Margin. For example, if Libor was 3.0% and the margin on the
loan was 2%, the fully indexed rate would be 5% (Index + Margin). The fully
indexed rate is the rate that your loan accrues interest at.
Now that we've covered the basic terms, let's examine the four payment
options
These payment options are:
1) Minimum Payment
This payment is a 30 year amortized payment based on the start rate of the
loan. When the minimum payment is made, the difference between the minimum
payment and the interest only payment is added to the principle balance of
the loan.
This payment is lowest possible payment and lets you keep more cash in your
pocket each month. This payment typically changes annually and is
recalculated based on the remaining principal balance of the loan, the
remaining loan term, and the current interest rate. A payment cap is usually
applied to ensure that they payment does not swing wildly from year to year.
A typical payment cap is 7%. For example, if your minimum payment was $1,000
in year one, the most it would be in year two is $1,070 and the least it
would be is $930.
2) Interest Only Payment
This payment is based on the fully indexed rate. These payments don't pay
down the principal balance of the loan.
In order to avoid deferred interest and negative amortization, each month
you will be given the option to make an interest only payment. This allows
you the benefit of keeping a low monthly payment and keeps the principal
balance of your loan at the same amount.
3) 30 Year Fixed Payment
This payment is based on the fully indexed rate. These payments do pay down
the principal balance of the loan.
It's calculated each month based on the prior month's interest rate, loan
balance and remaining loan term. When you choose this option, you reduce
your principal and pay off your loan on schedule.
4) 15 Year Fixed Payment
ly indexed rate. These payments do pay down principal balance of the loan.
If you want to build equity faster, pay off your loan quicker and save on
interest, this is the option for you. It's calculated to amortize your loan
based on a 15-year term from the first payment due date.
Let's take a look at a couple of examples.
Example 1:
$250,000 Loan Amount - 1.25% Start Rate - 5.5% Fully Indexed Rate
Payment #1 (Minimum Payment) - $833.13
Payment #2 (Interest Only Payment) - $1,145.83
Example 2
$450,000 Loan Amount - 1.25% Start Rate - 5.5% Fully Indexed Rate
Payment #1 (Minimum Payment) - $1,499.63
As you can see, there can be quite a difference between payment options!
If you want to run your own scenarios, We've built a simple, Excel based,
Pay Option Calculator that you can download for free. Check out the resource
box below for information on how to download this great little tool.
Hopefully, this gave you some insight into what an Option ARM loan is and
how it works.
If you are interested in learning more about this program, and if you are
eligible for it, your next step should be contacting a mortgage
professional.
IMPORTANT NOTICE
Beware companies or individuals that make you put money down or order an
appraisal BEFORE they agree to discuss your situation with you. Also, be
wary of those who won't talk to you until they pull your credit report.
While a credit report will be necessary if you decide to go forward, you
have the right to talk to someone about your options before they look at
your credit. These are frequently just sales tactics to make you feel like
you are obligated to go forward with that particular broker or lender.
Joe Ramirez and HomeLoanInfoCenter.net put today's confusing loan programs
into easy to understand terms. Run your own loan scenarios with a free copy
of our Pay Option ARM Calculator.
Article Source: http://EzineArticles.com/?expert=Joe_Ramirez
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Secrets of the Option ARM Loan (Newbie Guide)
