***As of September 2008, the Option ARM loan is extremely hard to find.  Many of these loans are in default causing the loan to be temporarily suspended.  If it does return, it may or may not resemble the below description. 

Today people need flexibile payments they can live with and the Option ARM gives you the lowest payment available on a real estate loan.

You want to own the house not have the house own you!

An option ARM is a good loan and can not harm you IF you know how it works.

An Option ARM gives you 3-4 monthly payments choices each month.  They payments are:

1. A minimum payment

2. An interest only payment

3. A 30 year principle and interest payment

4. A 15 year principle and interest payment

The minimum payment can be based on a payment rate of .99%.  That's right less than 1%. That payment, not rate, stays fixed for 1 year at a time.

The other 3 payments adjust monthly.

Example:

A $400,000 loan amount, lending 80% of the property value, with a .99% start rate.  For the example below, the figures would be for the 2nd monthly payment. 

1. The minimum payment based on a payment rate of .99%                             $1284.72

2. The interest only payment-based on an interest rate of 6.875%                    $2292.67

3. The 30 year principle and interest payment at a rate of 6.875%                    $2627.71

4. The 15 year principle and interest payment at a rate of 6.875%                    $3567.42  

 Confused? You should be!

How does an adjustable loan work?     

To understand how the Option ARM works, you first need to know how a basic adjustable loan works.

All adjustable loans have two main parts:  The margin and the index.

Margin + index = your interest rate

The margin is the lender profiit.  This figure never changes.  It's the only thing on your adjustable rate loan that stays constant. Hunt for the lowest margin possible to ensure a lower payment for the life time of your loan.

Margins are negotiable!

The index is an economic indicator that your loan is tied to that moves on a monthly basis.  There are several indicies that loans are tied to. LIBOR, 11th District Cost of Funds (also known as COFI), and TMAT's are the most used indecies today.  However there are many more.

What makes your monthly payment adjust?

Indecies all behave a bit different from one another.  Some are volatile and some are slow movers. I'll cover a few below.

LIBOR-  This is an acronym for London Inter Bank Offered Rate. It is tied to the European economy, specifically England.  Their economy closely mirrors our economy and tends to be the most volatile index and can jump around some, which makes your interest rate on your loan jump around a bit.  But when interest rates are on the downswing it is historically the lowest index, which makes your mortgage payment lower, so many borrowers are steered toward it for that reason.

The 11th District Cost of Funds (COFI)

The Federal Home Loan Bank divides the country up into districts.  The 11th district is comprised of the states of Arizona, Nevada, and California.

The cost of funds is the average deposit rate that member banks pay on savings, checking and c.d.'s and other savings types of accounts. As those rates go up, this index goes up, which makes your home loan interest rate go up or down.

Savings account rates don't jump from 1% to 2% from one month to the next.  Banks are slow to increase the rates they pay to their depositors (customers) so this index is more stable.  But in a downward interest rate cycle, this index is slow to react, meaning that your mortgage interest rate will not go down quickly like it would on a LIBOR loan.  But when rates go up, your mortgage payment won't shoot up right away either.  In all the 11th District Cost of Funds is the more conservative, safer index to be tied to if you have an adjustable rate loan.

Treasury Securities- T-Bills indecies

There are several types of indecies within the T-Bill family.  T-Bills are investment instruments that the United States issues, with various maturity dates and rates of return.  The 1 year average T-Bill is a common index in which real estate loans can be tied to.  It is closely tied to the United States economy.  Inflation in the United States can drive this index upward, so it is indeed cyclical and will react on a monthly basis.  If we are in a non-inflationary period, it is stable.

Ask for a 10 year history for each index before making your selection

You can ask your Loan Consultant for this information or you can find it online as well.  You will see on a monthly basis how the indecies have behaved.  Spikes in the indecies are caused by economic trends.  You will see peeks and valleys.  See which one you feel comfortable with, and make your decision from there.

How often does my payment change?

Just because indecies adjust monthly based on local, national, and global activity, doesn't necessarily mean your interest rate goes up right away. 

Some real estate loan payments adjust monthly, bi-annual, annually, or some interest rates stay fixed for several years before their first adjustment. The type of loan you select depends on how long you're looking to stay in the property, and your tolerance and risk you want to take! 

An experienced Loan Consultant should be able to present several loan options, and than based on your needs, educate you and ultimately help you make a decision.

Call me for for help or click here to apply on-line!

Kevin Walton

Cell

805-276-1942

Figuring your monthly payment

You take your margin, which is negotiated by you and your Loan Consultant, and add it to your index.  In the $400,000 loan example above, payments 2-4 are figured using a rate of 6.875% 

Let's say the COFI index has a yield of 4.02% for the previous month and your margin you negotiated is 2.875%.  Add the two together and you come up with 6.895%.  Round up or down to the nearest .125% = 6.875%

The next month the COFI index will have a new yield.  Add that to the 2.875% margin, which never changes, and you will get your upcoming interest rate for the next month.  This way you have an idea on what to expect.  Lenders use the prior month's index yield when figuring payments. 

To find what your monthly payments would be, click here to go to my loan calculators option.  Remember, you will need to know what index you want to use and what margin.  Margins run anywhere from 2.25% and 4%.

You can find the various index values in the financial section of your newspaper or Google it.  It isn't too hard to find. 

Call me for details and I will customize a loan for you!

Kevin Walton

Cell: 805-276-1942

Back to the Option Arm

The Option ARM is a monthly adjustable rate loan.  It is also commonly called a negative amortizing loan.  Go back up to the $400,000 loan example above.  The minimum payment is $1284.72, and the interest only payment is $2292.67.  That is a difference of $1007.95.  If $2292.67 covers 100% of the interest, what happens to the difference of $1007.95?

It gets added to the balance of your loan!  The balance goes up!

Every time you choose to make the minimum payment (you do have a choice), the balance on your loan goes up.

Why would someone select the minimum payment option?

Because the next month or somewhere down the line the borrower can "catch up" or double up on payments. Or maybe they are in a sales position that is cyclical, and bonuses are paid quarterly or annually, so the minimum payment is paid until they get their bonus which at that time they "catch up" the loan balance if they choose.

The minimum payment is an excellent option for a borrower who needs cash flow, for whatever purpose, from time to time.

The minimum payment is almost a separate loan within a loan.  While the other 3 payment options adjust monthly, index plus margin, the minimum payment stays fixed for 1 year at a time.  Your monthly mortgage payment coupon will list the payment options, and what the index figure is so you can see if it is higher or lower on a monthly basis.  Again options 2-4 will adjust monthly, and the minimum payment stays fixed for 1 year at a time.

Minimum payment example

Each year the minimum must go up 7.5% of itself.  So going back to the example above, the first 5 years of payment on a $400,000 loan would be as follows:

Year 1                                                                                                          $1284.72

Year 2      $1284.72 x 7.5% = $96.35 + $1284.72=                                               $1381.07

Year 3      $1381.07 x 7.5% = $103.58 + $1381.07=                                             $1484.65

Year 4      $1484.65 x 7.5% = $111.35 + 1484.65=                                               $1596.00

The minimum payment increases are a form of protection to make sure your balance of your real estate loan doesn't skyrocket.  Remember making the minimum payment makes the balance of your loan go up.  Take the difference between the interest only payment and the minimum payment and that difference is what gets added to your balance on a monthly basis.

Keep an eye monthly on the index, as it increases, the higher your loan balance goes if you make that minimum payment.  One month you may get $1000.00 added to the balance.  But the next month $1050.00 may get added to your loan balance if the index has gone up.  The same happens when the index goes down.  As the index goes down, less gets added to your loan balance when you choose to make the minimum payment

You control which payment you want to make each month

You can alternate payments each month.  Choose option 3 one month, than option 1 the next month, than option 2 the following month etc.......... It's up to you. 

Maximum loan balance

There is additional protection in that the lender will not let your loan balance go higher than 10-25% of the initial starting balance.

Example:

$400,000 x 110% = $440,000

You started with a balance of $400,000.  Your loan on this example can not go higher than $440,000 at any time. Once you reach that amount, the minimum payment disappears and your loan gets recasted (reset) to make sure the new balance which reflects increased balance from making the minimum payment, gets paid off in the remaining years left to pay the loan off.

So if at the end of 5 years, you've reached the maximum balance of $440,000, than your balance gets divided over the remaining 25 years (if the original loan term is 30 years), at the current index + margin interest rate.

Your payments 2-4 will remain and will show on your monthly payment coupon.  The payments will all go up 10-15% since the loan balance is higher.  This example only holds true if you've paid the minimum payment every single month.

5 year fixed payment Option ARM's are now available

Some lenders are also allowing balances to reach 115% instead of 110%. In exchange for the additional 5%, the start is bumped from say .99% to 3.5%. That way the loan balance doesn't go up so fast since the payment rate is higher.  Lenders are also giving 5 year fixed payment, not interest rate, terms on the Option ARM.  Payments 2-4 are adjusting monthly, but the minimum payment is fixed for 5 years say at 3.5%.  The payment would not go up 7.5% of itself every year.  The minimum payment is the same for 5 years, and payments 2-4 adjust monthly.

Don't be mislead by a Loan Consultant, that says this 5 year fixed payment covers 100% princinple and interest.  If the payment rate, not interest rate, sounds abnormally low, it's probably because it is a type of Option ARM loan.

Call me for details or click here to apply on-line today! 

Kevin Walton

Cell: 805-276-1942

How long will it take to reach the maximum balance?

It depends on how fast the index is moving and how often you've made the minimum payment.  The longest it will take is 5 years, since after 5 years the minimum payment disappears anyway.  But if your index is rising little by little every month, than your loan could possibly reach the maximum balance in 3 years.  So keep an eye on that index!

Minimum payment disappears after the recast 

As I mentioned above after the 5th year (on a 5 year fixed), whether you've ever made the minimum payment or not, the minimum payment disappears, and payments 2-4, remain.  The basically remains a monthly adjustable.  At this time, if people still want the minimum payment feature, they must refinance the loan, to obtain another 5 years of minimum payments. Once your loan reaches it's maximum allowed deferred interest balance, the minimum payment disappears and you have to start paying at least the 100% of the interest payment.  When the minimum payment disappears, this is called a recast. Your payment can and will go up depending on the number of months you chose to make the minimum payment. Loans without an initial fixed rate payment period can recast in as little as 2 years which can cause payment shock!  So be careful on what type of loan you select.

Qualifying for an Option ARM

Usually these loans require 10% downpayment or 10% equity (on a refinance), but there are some Option ARM's available with as little as 5% downpayment or 5% equity.  Minimum credit standards vary depending on a variety of factors but usually a 660-680 FICO credit score is acceptable for the 90% option, and a FICO credit score of 700-720 is required for the 95% loan option.  Payment rates vary on credit quailifications as well.

Call me if you have any questions or click here to apply on-line today!

Kevin Walton

Cell: 805-276-1942