It seems like everywhere you look lately you will see an advertisement that reads, "$150,000 refinancing for $381/month. Apply online today!". Just remember that, as your mother told you, "If it seems to good to be true, it probably is".
Option ARMs are a terrific way to get a very low beginning payment. What you never see advertised is the danger. Option ARMs are adjustable rate mortgages that begin at very low interest rates (typically 1.00%) and change up to market rates 30 days after you sign. What it means to the home owner is that the low payment he/she started with is NOT enough to pay for the interest the lender charged that month!
Most Adjustable Rate Mortgages (ARMs) remain fixed for 1, 3, 5 or longer years. This is not the case with Option ARMs. They only remain fixed for 30 days.
A good way to determine whether an option arm is for you or not is to be honest about your current situation. Most advice doled out by television pundits and journalists is given in a vacuum, and does not take into account the reality of your own situation. Ask yourself, have you been at risk of missing a mortgage payment, or are you credit card minimum payments starting to become overwhelming? If you were to be out of work for a month or two, would your be able to make all the payments necessary to stay current on all of your bills, including your house? Wouldn't paying off all those bills, reducing your monthly interest expenses (which you can write off on a mortgage, sometimes even the deferred interest) and getting access to a minimum payment which could allow you to withstand those tight times be a better alternative than one emergency spiraling your personal finances out of control? If things are tight, we even have loans available today which allow for no payments for 90 days after a cash out refinance, and these are hugely popular for debt consolidation. But you won't be able to qualify once your credit has already been damaged by a missed mortgage or credit card payment, so think proactively and protect your financial future today.
An Option ARM can be a good choice if your income fluctuates. During an average to good month, you can make a full payment. During a slow month, you can make an interest only payment. During a bad month, you can make a minimum payment.
While Option ARM's may present potential dangers to those homeowners who are not experienced in managing their cashflow wisely, there is a definite benefit to this type of loan when the right person utilizes it.
For example, an investor who wishes to flip their property soon after the purchase can indeed benefit from the low starting payments which typically start at 1.00% of the loan amount. Because of the low payments, not only is it easier to qualify for the loan, the investor also increases their monthly cashflow from rent payments received.
Depending on which institution is offering the Option ARM, interest rates are generally fixed for 30 days, 6 months, 1 year, 3 years, or 5 years.
If you are not an investor and plan on living in your home for several years then make sure the 30 year payment option is something you can comfortably afford. With an Option ARM you should avoid paying only the minimum payment more than once or twice a year including emergencies. If you continually make only the minimum payment then your loan will recast sooner and you may have a payment that you cannot afford. The interest only payment will at least keep your loan balance from increasing where as the minimum deferred interest payment causes the loan balance to rise.
Option ARM's are also an excellent tool for the savvy homeowner who realizes that in some markets the appreciation on their home more than offsets the interest that accrues during the years before recasting occurs. These savvy homeowners are able to save the money that would normally be used to pay towards their mortgage and increase their net worth thus being able to potentially payoff their mortgage that much quicker in the future.
If the minimum payment offered by the Option ARM mortgage is the only payment you can realistically afford then this loan is definitely not the best loan for you. Indeed, homeownership itself might not be suitable for you.
If the minimum payment is the only payment you can afford to buy a home I would advise you to reconsider purchasing altogether as you are probably better off renting for now. This loan was designed for individuals with considerable cash flow and/or savings who wish to choose how best to allocate their money on a month-to-month basis.
If you are considering an Option ARM loan to keep you in your home because your financial situation has changed I would encourage you to consider selling your property immediately. If you think it might take a while before the home is sold then go ahead and refinance without a prepayment penalty and then list the home for sale once the loan has closed. This advice might not make me win a popularity contest with the lenders I work with but it may very well allow you to avoid some nasty surprises later on.
It is important to be aware of the prepayment penalty and negative amortization associated with these loans as well. While they may save you dollars on a monthly basis, if handled carelessly, than can damage the equity in your home.
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