Option Arm Mortgage Loans: How do they work?

Most option arm mortgage loans give the borrower four ways to pay each month: a fixed payment for 30 years, fixed payment for 15 years, a payment for interest only, or a deferred interest or minimum payment.

The fully indexed rate is used to figure out the payments for the 30-year, 15-year, and interest-only terms. When you add the margin to the index, you get the fully indexed rate. Most likely, the index would be Libor, MTA, COSI, COFI, or CODI.

Here's what I mean:

Say that your margin is 3.15 and your index is 3.32. This would give you a total rate of 6.47 per cent (3.15 + 3.32 = 6.47). This is the rate that is used to figure out the payments for 30 years, 15 years, and just interest.

Depending on the lender and loan programme you choose, the deferred interest or minimum payment could stay the same for 5 years between 1% and 2%, or the PAYMENT could start at 1% and go up or down by a maximum of 7.5 % per year for 5 years.

The minimum payment of 1% to 2% is just the interest, and it is based on a 30 or 40-year amortisation.

An option arm loan is called a deferred interest or negative amortisation loan because the difference between the minimum 1 per cent payment and the interest-only payment is added to the loan amount each month if the consumer chooses to make the minimum payment. So the loan balance goes up instead of down over time.

When the loan reaches 5 years or when the deferred interest reaches 110% or 115% of the original loan amount, it will be recast. This means that it will become either an interest-only loan or a loan with both interest and principal at the fully indexed rate.

Since the fully-indexed rate is calculated every month, it could change from one month to the next.

The option arm mortgage loan has a few advantages:

1. The minimum payment is 100% interest, so the whole payment is tax-deductible.
2. If the client makes payments every two weeks, the amount of deferred interest will go down by about 30% or go away completely.
3. The client's cash flow goes up because of the minimum payment.
4. This loan gives the client a few ways to pay it back.
5. It also lets people use their mortgages as a way to save money and get rich.
6. The deferred interest is mortgage interest, so it might be tax-deductible.

Here are four important things to keep in mind when choosing a programme for an option arm loan:

1. Get a 30-year payment plan (not 40 years). The 1 per cent payment option will be available for longer if the loan is paid off over 30 years.
2. Pick an index that is less likely to change. Instead of the Libor, you could use the MTA.
3. Choose an option arm with a low-interest rate cap for the life of the contract.
4. Choose an option arm programme with a 115 per cent recast instead of a 110 per cent recast to increase the chances that the payment options will be available for the full 5 years.