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Flexible Payment Mortgages
By: LendingTree Editorial Staff
With most mortgages, your payment is the same every month. But what if your
paycheck isn’t so regular? Would you like to be able to vary your mortgage
payment depending on your cash flow? An option ARM -- also called a flex-ARM or
pick-a-payment loan -- allows you to do just that.
How does it work?
An option ARM is an adjustable-rate mortgage with a twist. You don’t pay a set
amount each month. Instead, the lender sends a monthly statement with up to four
payment options. You simply choose the amount you want to pay that month and
then submit your payment.
The options vary, but here’s the most common menu:
Minimum payment: This is calculated using an “initial” interest rate that can
start as low as 1.25 percent. Because this payment is so low, it’s useful for
months when you don’t have much cash on hand, perhaps because you are waiting
for a commission or bonus check. But any unpaid interest gets deferred, or added
to the principal of the loan, so your principal grows.
Interest only: You pay all the interest due, but none of the principal. This
doesn’t reduce your mortgage balance, but it allows you to avoid deferring
interest.
30-year amortized: This matches the monthly payment of a mortgage amortized over
30 years at your current interest rate. It includes both principal and interest.
15-year amortized: The same as above, but amortized over 15 years. This is the
highest monthly payment. Choosing it allows you to reduce your principal faster
than any other option.
The fine print
The biggest caveat with option ARMs is that those enticing initial rates are
short-lived. The low minimum payments that make these mortgages so attractive
can increase dramatically. In addition, every five years, the loan is recast --
that is, a new amortization schedule is drawn up to ensure that the remaining
balance will be paid off by the end of the loan’s term. When that happens, the
minimum payment can be pushed even higher.
What’s more, if you defer too much interest, you can reach what’s called
negative amortization. If your balance grows to 10 percent to 25 percent
(depending on state law) greater than the original principal, your loan is
automatically recast and you have to start paying the fully amortized rate,
which will increase your monthly payments.
Another potential downside of option ARMs is that they’re more complicated than
most other mortgages. Home buyers may be seduced without fully understanding how
much the minimum payments will increase over the long-term. When the monthly
amounts go up, these people can experience payment shock.
To learn more about flexible payment mortgages, visit http://www.lendingtree.com/cec/yourhome/yourmortgage/open-arms.asp
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