Below are the components to the option arm loan. Take a look
and don't worry if you don't fully understand
everything. We can clarify any
questions you my have. You can call us toll free 800-431-6962 ext
4 during business hours and Saturday if you have immediate
questions.
Don't forget to download our FREE OPTION ARM CALCULATOR at bottom of
page. It helps you compare the option arm to other loan programs,
shows you negative amortization and more.
Index: The
most common index used is the MTA.
Here is the description: "The 12-Month Treasury Average Index
(12-MTA) is based on the average annual yields on U.S. Treasury
Securities adjusted to a constant maturity of one year, as made
available by the Federal Reserve. The 12 months average is determined
by adding together the annual yields for the most recently available 12
months and dividing by 12."
Confused? Don't sweat it. This is what it means: Monthly Adjustable,
yes, monthly adjustable.
Margin: This
is the biggie as it sets your effective rate (the real interest rate).
Here is the description: The number of percentage points (for example,
3.5) the lender adds to the index rate to calculate the ARM interest
rate at each adjustment. The margin is set in the mortgage contract,
remains fixed for the term of the loan and is not impacted by the
financial markets and movement of interest rates.
Okay here is what you need to know. Index plus margin is your true
interest rate. So for example, the MTA right now is at 4.827* and if
your margin is at 3 then your effective interest rate is 7.827!
(Loan officers will try to make you believe your interest rate is
1%)
You would not take out a 30 Year Fixed at 7.827 would you?
Effective Rate:
As you have read, effective rate (real interest rate) is index plus
margin the only difference would be in the type of index the loan
officer is pitching to you. There are other indexes (or indices as the
smart people would call them) such as the COFI, COSI, LIBOR and of
course MTA. Let's not worry about the differences right now, the
important fact to know is how your effective rate is computed. Now you
know, right?
Payment Options:
Typically you will see four payment options after the first month. The
minimum payment, the interest payment and a 15 year and 30 year
amortized payment.
Minimum Payment:
Ahh, the minimum payment. This is the payment based on the start rate,
normally 1% although lenders are beginning to push up the start rate a
little bit. Here is what you need to know: The minimum payment does not
cover the interest payment due on the loan. Did you guess negative
amortization? If you did you are right!
Interest Only:
When you make the interest payment you will not have any negative
amortization. You will not pay down the principal but you will not add
to it. So, here is what you need to know about this: The difference
between your minimum payment and the interest payment is your negative
amortization. Yes, if you make the minimum payment the difference is
what is added to your loan balance. Lenders like to call it "deferred
interest" on the statement. I guess they think it will not be noticed.
What would the borrower think if they put "negative amortization" on
the statement? You got it.
Amortized Payments:
This is a payment based on repayment of principal and interest. No
negative amortization on amortized payments, your balance actually goes
down.
Yearly Increase:
This one is pretty simple. Your minimum monthly payment will increase
7.5% after each 12 months and remain constant for the following 12
months until the next adjustment period. So, your payment goes up once
per year. So, if your payment (excluding taxes and insurance) is $1000
per month your yearly increase would be $75.
Loan Term: The
most common is for 5 years although there are some that extend up to 10
years.
Negative Amortization:
By now you should know what this is but in case you forgot here it is
again. Negative amortization occurs when you make the minimum payment.
The amount of negative amortization is the difference between your
minimum payment and the interest only payment. This amount is added to
your loan balance. Lenders show this on your statement as "deferred
interest".
Prepayment Penalty:
This type of loan typically has a 3 year prepayment penalty although
you can find them with 1 year and in some cases without a prepayment
penalty. Loan officers usually do not disclose these options.
Payment Cap:
Normally the option arm has a 9.95% payment can although some have a
11.95% payment cap. Basically this means that the effective interest
(real interest rate) rate can go up to those caps. You remember the
effective interest rate don't you? Very rare for this to occur because
of the following component to an option arm.
Recast Clause:
Okay now you are reading insider secrets so pay close attention to
this: The recast clause says that if your loan balance goes up to a
certain amount over your original loan amount that the loan can recast
to a fully indexed rate. What this means is that potentially you can be
going along with your option arm happily making your minimum payments
and then you receive a notice saying your loan has recast and your
minimum payment is not your minimum payment anymore - it is now the
fully indexed rate payment! The payment can go up dramatically!
Usually the recast amount is 110% of the original loan amount although
some lenders offer a higher recast amount. No loan officer will ever
tell you or make you aware of this recast clause.