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Option ARM – The World’s Most Dangerous Mortgage
By: Charles Essmeier
Home prices have reached record levels, and in many parts of the country, homes
have become nearly unaffordable. Real estate has replaced the tech stocks of the
late 1990’s as the hot investment, and everyone has sold their stocks and jumped
into investment property. Real estate prices have increased at a far greater
rate than salaries, and the lending industry has attempted to solve this problem
by introducing a tremendous number of mortgage options for borrowers who barely
capable of purchasing a home. Most of these loan types feature adjustable
interest rates and minimum down payments. One of these, the option ARM, is the
most dangerous type of loan ever introduced. Borrowers who are considering an
option ARM should be aware that this loan could leave them with a loan that is
worth far more than the home it’s used to buy and with a loan that he or she
cannot afford to pay. The option ARM is not for the squeamish.
So what, exactly, is an option ARM? An option ARM is a mortgage with an
adjustable interest rate that typically gives the borrower four different
payment choices each month. The first choice is based on a 30-year amortization
table; the second on a 15-year amortization table. These would correspond to
payments for adjustable-rate 30 and 15 year mortgages, respectively. The third
choice is an interest-only payment, which pays the interest that accrues during
the month but pays nothing towards reducing the loan amount. The fourth choice,
the one that makes this loan so dangerous, is called the “minimum payment.” The
minimum payment is calculated upon the first month’s interest rate, which is
usually a very low “teaser” rate that can be as low as 1-2%. Most borrowers with
an option ARM opt to pay the minimum payment each month, and that’s where the
trouble comes in.
The loan carries and adjustable interest rate, and this rate can adjust as often
as every month. If the borrower is paying only the minimum payment, then he or
she isn’t even paying enough to cover that month’s interest on the loan. What
happens then? The unpaid interest that has accrued is added to the loan
principal. The principal can actually grow larger, and as interest due is
calculated on the loan principal, the interest due will increase, as well.
Interest rates are currently near all-time lows and are sure to increase. A
buyer who continues to make minimum payments on an option ARM will find that the
principal on the loan is actually increasing over time! This is known as
negative amortization.
In a negative amortization situation, only bad things can happen. The lender can
require refinancing under certain conditions stated in the loan agreement. The
buyer may find himself unable to pay the loan and may have to default. And the
lender could find himself holding a note that is worth far more than the house
that it represents.
The option ARM is a loan that is best suited to investors and homeowners who
only intend to keep the home for a short time. It is not a good choice for
anyone who may be using it to buy more home than he or she can afford.
Unfortunately, that describes a lot of buyers who are taking out this type of
loan. Anyone who is considering a home purchase should be very careful if this
type of loan is offered, as it could leave you both bankrupt and homeless.
About the Author:
©Copyright 2005 by Retro Marketing. Charles Essmeier is the owner of Retro
Marketing, a firm devoted to informational Websites, including http://www.End-Your-Debt.com,
a site devoted to debt consolidation and credit counseling, and http://www.homeequityhelp.net,
a site devoted to information regarding home equity lending.
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