Reply #32: Julie, you probably did not have an option ARM. [View All]

[Gormy Cuss]

Older ARMS tended to have very clear and simple terms. Your rate would be adjustable at X interval and the interest rate could rise no more than X %, for example. With these ARMS there was a certain level of predictability in the payment requirements and potential cost.

Option ARMS are called that because the consumer is given a number of options for payment each month. Here's an example:
1. Make monthly payments as if the loan will amortized in 30 years.

2. Make payments as if the loan will be paid off in 15 years

3. Make interest-only payments

4. Make payments based on a below-market interest rate with the unpaid interest rolled back into the mortgage debt.

The last is how people can get in big trouble because it represents a negative amortization on the note. Number # 3 is treading water because no principal is paid. Note that the homeowner can choose any of the above each month. If your income stream is lumpy, it's a good product because you can choose the negative amortization option when the cash flow is low.

If on the other hand all that you can afford is option 3 or 4, you are in deep trouble when the rate is adjusted upward. Some option mortgages adjust MONTHLY, so it's difficult to project how much money you will need to set aside for the mortgage. Unless your property is appreciating rapidly you may not be able to refi because of the debt to income ratio.