can anybody explain me whats an option arm loan program?
mortgage companies offer something like this… and say interest is only like 1% for 5 years…
how does this work?
ARM — > Adjustable Rate Mortgage
You have to have VERY GOOD Credit to get 1% they don’t offer that anymore
unless they buy down the rate
Carol Wilson
Nationwide Loan Consultant
Starlite Funding
different companies call me every day and offer me 1.25%
are these loans beneficial? or is there some kinda catch to it that the borrower overlooks??
What is that on? Purchase, Refi, Straight purchase, are you buying down the rate?
I have not done a loan that offers 1.25% and if you have a lender that is going to give you that please give me that lenders infor
Carol Wilson
Nationwide Loan Consultant
Starlite Fundingmation so I can register with them.
I have been offered and accepted a 1.25% Option ARM loan on investment properties. If you have some equity available, I think it is an investor’s dream. I know of several lenders who are offering them; 80% LTV NOO, 90% LTV Owner occupied. I bought a property with a $450K 1st mtg. Payments are $1191 plus taxes & insurance.
Da Wiz
So I can better understand what you are doing can you please give me your contact information so I can talk to you.
Carol Wilson
Starlite Funding
Carol, are you brand new to the game or are you just playing dumb?
n604, here’s your answer.
Yes there is a such thing as a 1% rate, or 1.25% rate. and yes mortgages advertise this as an “amazing” rate that is sooooo difficult to get into. “the lowest rates out there” is a common statement made.
Anyway, here’s the deal. And this is a brief overview, they can be complicated loans.
1% is your minimum payment rate. This is the minimum amount you have to pay each month. However, you are actually paying more than that 1% in interest, it’s just being deferred, hence the term “negative amortization”. you are increasing your loan amount rather than paying it down. Here is a scenario
You get a 1% option arm. You have a 3% margin which is added to the indexed rate of (for example) 4.5%. This adds up to 7.5% that you are paying in interest per month, but you only HAVE to pay the 1% rate. on a 100k loan it would look like this.
minimum 1% payment$321
Interest only payment at the fully indexed rate of 7.5% $625
Fully amortized payment (paying 30 mortgage PI)$699
You have the option of paying whichever of these 3 payments you prefer each month (hince the title option arm). If you choose the lowest payment, the difference between that payment and the Interest Only payment will become deferred interest, which will be added to your loan amount.
I hope this was helpful. Please contact me if you have any other questions. I’d be happy to help.
Wow Mark,
You almost seemed intelligent.
But when you had to put someone down to make yourself look good just reminded me of how many %$# are out there
Did you ever think that she might not have understood the question?
And needed clarification. She didn’t solicit the guy she was trying to help him JERK.
thanks everyone for the helpful info:
here is the situation… i got this property:
http://www.reiclub.com/forums/index.php?board=26;action=display;threadid=16612
and every day a ton of mortgage brokers call me asking me if i wanna lower my rates. they all want me to put the first mortgage and the 2nd heloc and my cc debt into one big loan with a fixed rate. other than that, they also offer me option arm programs.
i wanna pull out the 400-500k equity in a way that is best for me to use it for real estate investing. with a HELOC, if i’m not using the money and its just sitting there, i dont have to pay anything, right? but with regular loans the money is taken out, and i gotta pay the interests and installments…
so it probably wouldnt be a good idea to use an option arm program for this purpose, right?
n604
A 1.25% 5-yr. option ARM is the ONLY way to go for investors. If you have equity in the property, you can do very well. For instance, a home I bought has a $450K 1st on it. My payment: $1191, plus taxes and insurance.
First listed at $595K and sold at $575K, it fell out of escrow. I got it for $499K. A 3-year triple net lease to my tenant at $3000 per month will bring in a nice monthly cash flow, don’t you think?
We’ll share future appreciation 50/50 and let’s say we sell in 3 years at $650K and let’s say there was enough negative amortization to eat up $50K (just an example, don’t come hitting me up with exact figures). We each make another $50K, which means my tenant will get back half the rent money he paid in three years. And, I’m also able to depreciate the property.
Take a long hard look at these loans. They are great for the investor who wants to buy and hold for up to 3-5 years.
Da Wiz
For what you want to use the money for, no, do not do an option ARM. A HELOC is what you are looking for. Why pay interest on money your not using?
thanks for the tips. both are useful.
shaun,
the house i wanna pull the equity from is where i live, and i have no idea when i’m gonna sell it. so i’m gonna go with a HELOC with this house. you are right. why pay interest on money i don’t necessarily use all the time?
mtn,
what you are saying sounds like an awesome plan. this opens up a ton of possibilities for me to think about. i’m gonna definitely look into using these tricks on investment properties i’ll buy in the future.
thanks
Option ARM
This loan program is an adjustable rate mortgage with added flexibility of making one of several possible payments on your mortgage every month, in order to better manage your monthly cash flow.
It’s low introductory start rate allows you to make very low initial mortgage payments and low qualifying rates enable you to qualify for more home.
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 can always avoid deferred interest by choosing the interest-only payment option.
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 30-year loan, or you can choose the 15-year payment option for the fastest equity build-up.
In most cases, you can also make additional principal payments which reduce the amount you need to pay in later months.
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.
Option ARM loans have four major types of payment options:
• Minimum Payment
With the minimum payment option, your monthly payment is set for 12 months at your initial interest rate. After that, the payment changes annually, and a payment cap limits how much it can increase or decrease each year.
If you make the minimum payment after the end of your initial interest rate period, which holds only for the first month, it may not be enough to pay all of the interest charged on your loan for the previous month and the unpaid interest will be added to the principal balance you owe (will be deferred).
• 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. The interest-only payment option, however, is not available if the interest-only payment would be less than the minimum payment. Please note, that this payment option does not result in your principal reduction.
The interest-only payment may change every month based on changes in the ARM index used to determine your fully indexed rate.
• Fully Amortizing 30-Year Payment
With fully amortizing payments, you pay both principal and interest and keep your loan on schedule. Your payment is calculated each month based on the prior month’s fully indexed rate, loan balance and remaining loan term.
• Fully Amortizing 15-Year Payment
If you prefer to put your loan on an accelerated schedule and can afford higher monthly payments, the 15-year payment option allows you to repay your loan twice as faster and save more than half the total interest costs of a 30-year loan.
Please note, that this payment option is offered only on the 30-year (or 40-year) term. It will cease to be an option when the loan has been paid to its 16th year.
These options should be clearly marked on your loan statement, so it is very easy to figure out how much you should pay each month. Just enter the correct amount in the payment coupon section of your statement.
Option ARM loan programs are becoming more and more popular today, and there are many variations of this innovative home financing product on the market: Pay Option ARM, Pick-A-Payment Loan, 1 Month Option ARM, CashFlow Option Loan, LIBOR (or 12-MAT) Pay Option Loan, etc. If you are thinking about applying for an option ARM, it is important to shop carefully and investigate several loan products, to find the one best for you.
Option ARM loan programs may vary in the initial rate, negative amortization and lifetime caps, ARM index, or optional features, however, when comparing one option ARM with another, pay close attention to the margin and the fully indexed rate. Keep in mind that the initial interest rate holds only for the 1st month.
What features to compare with different Option ARM loans?
Loan Term
Option ARM loans are available for 30 or 15 years. *
Initial Interest Rate
Your Minimum Payment Rate or ‘Start Rate’. It may vary from 1.25% up to 3.95% and depends on your Loan-to-Value Ratio (LTV).
Initial Interest Rate Period (Introductory Period)
With 1-month option ARMs, the initial interest rate holds only for the first month, thereafter the interest rate may change monthly.
During the introductory period: After the introductory period:
Monthly Payment = Minimum Payment
Interest Rate = Start Rate
Monthly Payment = Minimum Payment
or Interest-Only Payment
or Fully Amortizing 30-Year
or Fully Amortizing 15-Year
Interest Rate = Fully Indexed Rate
Periodic adjustments after the introductory period:
Event Loan Feature Change Frequency Cap
Monthly Interest Rate Adjustment Fully Indexed Rate
Monthly Lifetime Cap
Annual Minimum Payment Change Minimum Payment
Annually Payment Change Cap
Loan Recast
Minimum Payment
Every 5th Year None
Other adjustments:
Event Loan Feature Change Frequency Cap
Loan Recast (negative amortization limit is reached)
Minimum Payment
Irregularly
None
Fully Indexed Rate (FIR)
The sum of the margin and the most recent index figure available prior to a scheduled interest rate change date. Subject to the interest rate caps.
Interest Rate Adjustment Period
The time between interest rate adjustment dates.
With option ARMs, the adjustment period is usually set to 1 month: the fully indexed rate may not change more than once every month based on the movement of the index.
Maximum Rate
See: Lifetime Cap.
Lifetime Cap
A lifetime cap limits the interest rate increase over the life of the loan. It protects you financially and usually is expressed as maximum rate. Lifetime caps may vary from 9%-10% up to 19%.
Lifetime Floor
See: Margin.
Minimum Payment
Initially (for the first 12 months), the minimum payment is calculated using the start rate, the amount you borrow and the loan term. Thereafter, it is recalculated annually.
Example:
Loan Amount: $200,000.00
Initial Rate: 1.25%
Index: 4.282 (MTA as of May 2006)
Margin: 2.75%
Payment Cap: 7.5%
Fully Indexed Rate: 7.032% ( = index + margin )
Minimum Payment Changes:
Year 1 $666.50 = Base of Minimum Payment
Year 2 $716.49 = $666.50 + 7.50%
Year 3 $770.22 = $716.49 + 7.50%
Year 4 $827.99 = $770.22 + 7.50%
Year 5 $890.09 = $827.99 + 7.50%
Minimum Payment Adjustment Period
The minimum payment adjustment period is usually set to 12 months, unless negative amortization limit is reached.
Minimum Payment Change Cap
A limit on how much the minimum monthly payment can change at each adjustment. With most option ARMs, your payment cap will be 7.5% of minimum payment amount in first five years. It means that on any Payment Change Date, the minimum payment cannot increase or decrease by more than 7.50% (unless the loan is
recast or the negative amortization limit is reached).
Negative Amortization Cap (Also known as: Balance Cap, Negative Amortization Limit, Negative Amortization Ceiling)
It limits the loss of equity in your home when low monthly payments do not cover fully the interest rate charges agreed upon in the mortgage contract and is usually set to 110% - 125% of your original principal balance. When the negative amortization limit is reached, the minimum payment increases immediately: the payment required to fully amortize the loan over the remaining term becomes the new minimum payment, and the payment cap does not apply.
Payment Recast Period
Recasting (or re-calculating your loan) is another way of limiting negative amortization and keeping your loan on the original schedule. Option ARM loans are recast every five years (or sooner, if the negative amortization limit is reached). This re-calculation is based on the outstanding principal balance, the remaining term and the fully indexed rate. When the loan is recast, the payment required to fully amortize the loan over the remaining term becomes the new minimum payment, and the payment cap does not apply (the payment cup, however, will go back into effect immediately after the recast, and will hold until the next time your loan is recast).
Index Options
Your interest rate is usually based on one of the following indexes:
• Monthly Treasury Average (MTA)
• Cost of Savings Index (COSI)
• London InterBank Offered Rate (LIBOR)
• 11th District Cost Of Funds Index (COFI)
These indexes change once a month.
Margin
The number of percentage points (for example, 2.75) 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.
Caps
Option ARMs don’t have First Interest Change Cap or Periodic Interest Change Cap.
They have:
• Lifetime Cap (or Maximum Rate)
• Lifetime Floor (or Margin)
• Payment Cap (or Minimum Payment Change Cap)
• Balance Cap (or Negative Amortization Limit)
Option arm are for investor for short term to use to free cash reserve and have positive cash flow and tax write off.
Great post, John. They are wonderful for investors who are able to acquire some equity when they buy. Example: I picked up a $575K property for under $500K, with a 1st mtg. of $450. It’s a 5-yr ARM @1.25%. Payments: $1191 plus taxes and insurance. If I make it available to a tenant/RB at $550K with a mo. lease payment of $3600, can you say positive cash flow?
$2200+ per mo. for 36 mos = $80K
$51K equity bump
Sell to tenant or buyer in 3 years for $650K. I split appreciation with my tenant 50/50 and make another $50K.
That’s $180K profit in 3 years minus about $40K in negative amortization. There is no other loan that can provide that kind of return to a small investor.
Da Wiz
Wiz, I wish there was other investor like you out there. It would make my job easrier. I have one in Florida that need to un loand 4 properties. He is over his head. In time of trouble and not fully understanding how option arm work I see a lot of investment properties coming on the market. A short sale drive the value down . Meaning higher LTV and with FED hike again. HUD redict 40 million foreclosure in the next 5 years. I see and hear so many green investors , foreclosure business people… new and old account executive that do not know thier craft and newer loan officer and realator so green. Are we doom?