Pay Option ARMS - What Are They and How Do They Work
So what exactly is a Pay Option ARM loan, a Smart Choice Loan, a Secure Advantage loan, Pick a Payment loan, or any of the other variations to the name of the loan most commonly referred to as a Pay Option ARM loan? A Pay Option ARM loan is a loan that provides you with multiple monthly payment options each month when you are making a payment.
Many of these types of loans, offer 3-4 different payment options.
For example a Payment Option ARM that offers four payment choices may offer an interest only payment, a 30 year fixed payment, a 15 year fixed payment, and a lowest monthly payment option.
Rates on these programs usually start as low as 1% and the minimum payment rate can be based on this start rate for as long as 5 years.
Sounds great so far, so where do I sign up? The part you are not told about or that there is not much focus on, is the fact that your minimum payment is going to usually (almost always) be negative amortizing.
This means that you are not even paying enough of a payment each month to cover the interest portion of your payment, and your mortgage balance is actually rising instead of decreasing.
Even though your lowest payment option may be based on a rate of 1% or 2% or whatever it may be, the actual rate of the loan is based on the current market conditions and your rate index plus your rate margin.
The bigger the difference between your start rate and the actual fully indexed rate means more negative amortization.
Your rate margin is a fixed part of your rate that you need to pay a lot of attention to, and your index rate is the adjustable part of your rate that is based on a rate index such as Prime, LIBOR, MTA, etc...
Rates have been headed upwards and so have these indexes.
This means that the higher your rate increases, the more negative amortization you are experiencing and the more your mortgage balance is increasing each month if you choose to only make the minimum payment option.
Many mortgage professionals are increasing your rate margin and they are making top dollar to do so.
By a mortgage professional increasing your rate margin, they are being compensated by the lender for charging you a higher rate.
Most consumers are not aware of the margin, what it should be or what it could have been and do not know enough to ask, so they end up with a high margin.
It is too easy for mortgage professionals to increase your margin, because most consumers do not even realize what it is and they are not being told about what their fully indexed rate is (margin + index).
Unlike a traditional mortgage where most consumers see what their exact rate is on their mortgage on all of their closing paperwork in black and white, the rate on the Pay Option ARM loans is not always that easy to understand.
This ends up meaning higher interest rates, higher payments and more negative amortization.
These loan types are not all bad though and when used properly, in the right situations for the right borrowers can be a very strong tool for some borrowers.
Pay Option ARMs can be very beneficial to self-employed borrowers, commissioned borrowers, real estate investors and anyone else who has income that fluctuates or is seasonal or anyone that needs to improve their monthly cash flow for a temporary basis.
However, because these types of loans are being sold to consumers who are not right for them and because these loan types are being sold under deceptive terms, there is a lot of confusion about Pay Option ARM's.
Therefore, always make sure you read in your final paperwork in detail, the rate and margin information, and ask a lot of questions about anything you are unsure of.
If the deal sounds too good to be true, show the paperwork to a friend, attorney, or another mortgage professional (that you trust) and ask their opinion of what they think about the deal you are getting.
Remember, a house is not only a large investment, but a large liability and it should be treated accordingly.
Do not just take the word of the person selling you on the loan and seek other advice if needed.
Many of these types of loans, offer 3-4 different payment options.
For example a Payment Option ARM that offers four payment choices may offer an interest only payment, a 30 year fixed payment, a 15 year fixed payment, and a lowest monthly payment option.
Rates on these programs usually start as low as 1% and the minimum payment rate can be based on this start rate for as long as 5 years.
Sounds great so far, so where do I sign up? The part you are not told about or that there is not much focus on, is the fact that your minimum payment is going to usually (almost always) be negative amortizing.
This means that you are not even paying enough of a payment each month to cover the interest portion of your payment, and your mortgage balance is actually rising instead of decreasing.
Even though your lowest payment option may be based on a rate of 1% or 2% or whatever it may be, the actual rate of the loan is based on the current market conditions and your rate index plus your rate margin.
The bigger the difference between your start rate and the actual fully indexed rate means more negative amortization.
Your rate margin is a fixed part of your rate that you need to pay a lot of attention to, and your index rate is the adjustable part of your rate that is based on a rate index such as Prime, LIBOR, MTA, etc...
Rates have been headed upwards and so have these indexes.
This means that the higher your rate increases, the more negative amortization you are experiencing and the more your mortgage balance is increasing each month if you choose to only make the minimum payment option.
Many mortgage professionals are increasing your rate margin and they are making top dollar to do so.
By a mortgage professional increasing your rate margin, they are being compensated by the lender for charging you a higher rate.
Most consumers are not aware of the margin, what it should be or what it could have been and do not know enough to ask, so they end up with a high margin.
It is too easy for mortgage professionals to increase your margin, because most consumers do not even realize what it is and they are not being told about what their fully indexed rate is (margin + index).
Unlike a traditional mortgage where most consumers see what their exact rate is on their mortgage on all of their closing paperwork in black and white, the rate on the Pay Option ARM loans is not always that easy to understand.
This ends up meaning higher interest rates, higher payments and more negative amortization.
These loan types are not all bad though and when used properly, in the right situations for the right borrowers can be a very strong tool for some borrowers.
Pay Option ARMs can be very beneficial to self-employed borrowers, commissioned borrowers, real estate investors and anyone else who has income that fluctuates or is seasonal or anyone that needs to improve their monthly cash flow for a temporary basis.
However, because these types of loans are being sold to consumers who are not right for them and because these loan types are being sold under deceptive terms, there is a lot of confusion about Pay Option ARM's.
Therefore, always make sure you read in your final paperwork in detail, the rate and margin information, and ask a lot of questions about anything you are unsure of.
If the deal sounds too good to be true, show the paperwork to a friend, attorney, or another mortgage professional (that you trust) and ask their opinion of what they think about the deal you are getting.
Remember, a house is not only a large investment, but a large liability and it should be treated accordingly.
Do not just take the word of the person selling you on the loan and seek other advice if needed.
