Option ARMs

The following is an explanation of how an Option ARM works.

The Basics:

Option ARMs provide excellent financing because they keep your mortgage payment and your interest rate low.

Your monthly payments are dramatically lower with an Option ARM than with a conventional Fixed rate loan or an interest only loan (about half). This leaves more of your income available for you.  

It should also be noted that in comparison to any other type of ARM loan the Option ARM is considered to be the "Safe ARM". This is because of the stability of the payment and interest rate on an Option ARM. The payment predictability of the Option ARM is a result of payment Caps and the interest rate stability of the Option ARM is a result of non-volatile indexes that they are tied to.   

Option ARMs are more complex than fixed rate loans and interest only loans but it is worth taking the time to learn about them and the benefits that can give you.

How it works:

Annual Payment Adjustments:

The payments not only start out lower than any other type of mortgage but they stay lower for years as a result of payment caps. Your monthly payment starts out based on an interest rate such as 1% fully amortized over 30 or 40 years. We recommend 40 years when available.

The monthly payment is fixed and can only be adjusted once a year but not more or less than the annual payment cap of 7.5%. For example, your starting payment on a $400,000.00 loan would be $1,011.00 per month. Although it can be adjusted up or down once each year, the maximum that it can be increased over the next five years would be as follows:

Maximum payments for first five years:

       Payment              Max. adjustment

1st year $1,011.00 *

2nd year  $ 1,086.83 *        ($75.83) 

3rd year  $ 1,168.34 *         ($81.51)

4th year  $ 1,255.97 *         ($87.63)

5th year  $ 1,350.17 *          ($94.20)

How much would your monthly payment be if you just got a 30 year fixed rate loan at say 6.75%? It would be $2,594.00 each month. With an Option ARM you monthly payment would only be $1,011.00! This  will have saved $85,172.28 in monthly payments over the first 5 years that could be used for home improvement, savings to earn interest in the bank, investing in more real estate, college tuition. What could YOU use an extra $85,172. for?

From a cash flow point of view, the lower monthly payment (and payment cap) gives you piece of mind.

There are a few nuances with regard to the payment cap that should be taken into account as follows:

Special Features:

 1. On our best program the anniversary of the 10th year and each 5th year thereafter, the payment cap does not apply. On these anniversary dates the loan payment will be adjusted to be fully amortized over the remaining life of the loan. 

Since your payment adjusts once each year (subject to the payment Cap.).  The loan has a self leveling effect as a result of the rate and payment adjustments. It is normally a non-event and results in only a minimal payment adjustment on the 5 or 10  year anniversary dates. However, depending on other factors such as how low your payment starts and the direction that interest rates are moving during the early years of the loan, it could result in a greater than 7.5% payment adjustment up or down on each 10th and each 5th year thereafter. This is a 7.5% payment adjustment that we are talking about not an interest rate adjustment.

2. Our best program has a 125% recast rate. This means that If your outstanding loan balance reaches 110%, 115% or 125% of your original loan balance, depending on which Option ARM program you obtain, your payment cap will not apply for that month and your loan payment will be adjusted to be fully amortized over the remaining life of the loan.  

3. Our best program allows the borrower to call in and have their payment adjusted back to the original low start rate with all other rates and terms remaining the same. This two time payment modification option  can be used anytime during the life of the loan after the first 12 months as long as the lender's customer retention department continues to offer this payment modification option. It has been available for the past 7 years.  Requirements include a $200 modification fee and the last 12 payments must have been made on time. 

4. Our best program allows the borrower to call in and have their Margin adjusted down effectively reducing their interest rate one time (Margin Modification). This one time margin modification can be used anytime during the life of the loan after the first 12 months as long as the lender's customer retention department continues to offer this margin modification option. Requirements include a $200. modification fee and the last 12 payments must have been made on time.

5. Our best program allows the borrower to call in and switch their loan program to a fixed rate program. This one time modification can be used anytime during the life of the loan after the first 12 months as long as the lender's customer retention department continues to offer this margin modification option. Requirements include a $200. modification fee and the last 12 payments must have been made on time.

This program also offers an optional fixed rate conversion option feature. 

Monthly Interest Adjustments:

The interest on an Option ARM is adjusted monthly. It is based on published changes in the index the loan is tied to. We offer 5 indexes. MTA, COFI, CODI, COSI and the Libor. Not all of these indexes are offered on all of our programs. We have programs available that can utilize any of these four indexes. At Option ARMs Direct, we recommend any of the following indexes in the following order of preference, COFI, MTA, COSI, CODI and Libor. They are all very good indexes.  The margins are different on each so your rate is about the same regardless of which index your loan is tied to.  Our best program is tied to the COSI index. We have a tab linked to a page on this web site for each of these indexes that show the index history. At the bottom of each index page you can click on a link that will give you a 10 year historical graph comparing the indexes to the MTA or each other.  

The other factor that makes an Option ARM a "Safe ARM" is that the indexes that they are tied to are dampened and slow moving. This gives the home owner a comfort level because the interest rate  charged to the borrower is non-volatile. The COFI for example rarely moves more then 1/10th of one percent up or down a month and is the slowest to react to market interest rate changes. The COSI is our first choice because the final interest rate charged runs about 1/2% lower than the MTA or COFI.

Other ARMs that are tied to indexes such as the Prime Rate, Treasury and Fed Funds rate and move very quickly. They are extremely volatile indexes. A rate hike on a typical ARM tied to one of these other indexes has an almost immediate effect on the interest rate that you pay. Further, these types of loans do not have payment caps and generally adjust every 6 months to fully amortize the payment over the remaining life of the loan. Although they may have a 2% annual interest rate cap, the effect of the rate changes on your monthly payment can be financially devastating. The effect of most types of ARMS and equity lines of credit are extreme in the volatility of payments and interest rates. This risk is avoided and the borrower gets a smooth ride with an Option ARM. With an Option ARM, changes in monthly payments and interest rates are much more gradual.   

The interest rate that you are charged will be adjusted each month to be equal to the published index rate plus the margin. The margin is stated on your Mortgage Note and will not change for the life of your loan (unless you have our best program and obtain a reduction from a margin modification).  

Hybrid Option ARM 

5 Year fixed Rates & Payments:

This is the a new type of Option ARM also known as the "5 Year secure, modified or hybrid Option ARM". With this type of Option ARM your note rate is fixed for 5 years or for the life of the loan which can be 30 or 40 years. 

There are several variations of this types of Option ARMs. They all start you off with lower monthly payments then an interest only loan.

One type: The rate is fixed for 30 years but the payment starts low and has a 7.5% payment cap for 10 years. Call for quote. 

Another type: The rate and low payment are fixed for 5 years. Call for quote.

With any of 5 year fixed rate Option ARMs you have the benefit of a constant interest rate and lower payment for 5 years.

When it comes to the 5 year hybrid Option ARMs each lender or investor their own version that is a variation of what is stated here. There have been a lot of changes with these programs so it will require review of the specific loan features on any product that is available at the time of your application. But in general the payments will be lower on our standard option arm but the rate will be lower on the hybrid option arm.

Currently we are recommending "our best program" because of all the great features. And more specifically because the real estate market is off and lenders are tightening guidelines and going out of business. We don't know how long it will take before the markets stabilize and we see a good market for real estate and lenders again. So it is much safer to go with our best program which is the Option ARM offering the 125% recast rate and a 10 year payment cap. This way you don't have to worry about the loan because the payments will remain lower for 10 years!    

For questions, or a free payment quote, please send us an e-mail at, Steve@optionarmsdirect.com .

 This information is provided by Steve Spiro a licensed California Mortgage Broker with 30 years of real estate finance experience.

ADJUSTABLE RATE MORTGAGE DEFINITIONS

 Copywrite 2007 Option ARMs Direct

 ARM – Adjustable Rate Mortgage

 COFI – 11^th District Cost of Funds index

 COSI – Cost of Savings index

 CODI – Certificate of Deposit index

 CLTV – Combined loan to value

 C/O – Cash Out

 Conforming loan Amount – A loan amount under $417,000.

 ELOC- Equity Line of Credit

 LTV – Loan to Value

 LIBOR – London Inter-Bank Offered Rate index

 Margin – The percentage amount that is added to the index to determine the fully indexed interest rate

 MTA- 12 month Treasury average index

 Non-Owner – A property that is non-owner occupied.

 Jumbo Loan – A loan amount over $417,000.

 Hybrid Option ARM – An Option ARM with a fixed payment or rte for a period of time

 HELOC Home Equity Line of Credit

 Index – The published rate that your Adjustable Rate Mortgage is tied to.

 POA – Payment Option ARM

Payment Cap. – The Max. % rate which the loan payment can increase or decrease in any one annual payment adjustment 

 Pre-payment penalty – The amount that is charged if you pay your loan off early

 PPP – Same as above

 O/O – Owner Occupant

 Re-Cast – Loan payment being changed without regard to any payment Cap. to be the correct amount to fully amortize the remaining balance of he loan over the remaining life of the loan.

 Re-set – same as above

 Re-Cast rate – the percentage of he original loan amount that unpaid loan balance can reach before loan re-casts without regard to payment Cap.