What is a Payment Option ARM loan program?
This loan program is an adjustable rate mortgage with a low initial monthly payment that will increase each year for the first five years. It also offers other payment options to help you budget your monthly cash flow.
- Minimum Monthly Payment
- Interest Only Payment
- 30-year Amortized Payment
- 40-year Amortized Payment
- 15-year Amortized Payment
Its low introductory start-rate allows you to make very low initial mortgage payments and low qualifying rates enable you to qualify for more home.
Calculating the monthly payment: The payment during the first five years starts by calculating the payment using the initial low introductory rate, usually 1 percent to 2 percent. That will be your payment rate. Each year the payment will increase 7.5 percent for the first five years.
Minimum Payment Changes: | ||
---|---|---|
Year 1 | $1000.00 | = Base of Minimum Payment |
Year 2 | $1075.00 | = Year1 $1000.00 + 7.50% |
Year 3 | $1155.63 | = Year2 $1075.00 + 7.50% |
Year 4 | $1242.30 | = Year3 $1155.63 + 7.50% |
Year 5 | $1335.47 | = Year4 $1242.30 + 7.50% |
In year six, the payment will then be calculated using the index rate plus the margin rate, and amortized over the remaining term of the loan. On a thirty-year loan, the remaining term is twenty-five years, and on a forty year loan the remaining term is thirty-five years.
The note rate is the interest rate the bank will charge you each month. Some programs will use the introductory rate as the note rate for the first three months. After that introductory period, the note rate will then adjust to the index rate plus the margin rate.
EXAMPLE: | COFI index | 3.626 |
Margin | 2.250 | |
Index + Margin | 5.876 | |
Payment Calculation: | ||
Year 1 | use Introductory Rate | 1.000% |
Term | 30 years | |
Initial Loan Amount | ||
Year 6 | Index + Margin | 5.876 |
Term | 25 years | |
Loan Amount plus Deferred Interest |
Deferred Interest: The minimum payment option can help keep your monthly payments affordable. If the minimum monthly payment is not sufficient to pay the monthly interest due, you will then have deferred interest. That is, the interest that was not paid will be added to the principal loan balance. Your loan balance increases each month. This is where the term negative amortized loan comes from. The balance increases, instead of decreases like in a normal loan. You can always avoid deferred interest by choosing the interest-only payment option.
Payment Options: With the option ARM, you generally have at least two fully amortized payment choices, leading to a quicker loan payoff. If you prefer to pay off your loan on schedule, you can make the fully amortized payment based on a thirty- or forty-year loan, or you can choose the fifteen-year payment option for the fastest equity buildup.
Option ARM loan programs are right for you if you'd like to own your property only for a short time, and prefer affordability and flexibility in your monthly payment. However, if you select the minimum payment option in the early years, you should be prepared for possible sudden increases in your monthly payments thereafter.
Four types of payment options:
Minimum Payment
With the minimum payment option, your monthly payment is set for twelve months at your initial interest rate. After that, the payment changes annually.
Interest-Only Payment
With the interest-only payment option, you can avoid deferred interest, when the minimum payment is not enough to pay the monthly interest due. This payment option does not result in your principal reduction. The interest-only payment will change every month based on changes in the ARM index used to determine your fully indexed rate.
Fully Amortized Fifteen-, Thirty- or Forty-year Payment
Fully amortized means you have equal monthly payments for the entire term of the loan, and have a zero balance at the end. With fully amortized payments, you pay both principal and interest. Your payment is calculated each month based on the prior month's fully indexed rate, loan balance and remaining loan term.
Index plus Margin
The index is the base rate used to determine your interest rate. Most people are familiar with the Prime rate, T-bill or Cofi. Option ARM programs are is usually based on one of the following indexes:
- Monthly Treasury Average (MTA)
- London InterBank Offered Rate (LIBOR)
- 11th District Cost Of Funds Index (COFI)
- Cost of Savings Index (COSI)
The Margin is the number of percentage points (for example, 2.75) the lender adds to the index rate to calculate the ARM interest rate, or note rate, at each adjustment. The margin is fixed at the time the loan is funded.
The interest rate you will be charged is the index rate plus the margin.
The Payment Option ARM goes by several different names: Option ARM, PayOption, Pick-a-Payment, Neg Am Variable, Negative Amortized loan.