Better rate than you ever imagined?  We always LOVE "The Deal", and are constantly on the look-out for the mortgage offer that looks like the "best deal" or "the lowest interest rate".  When looking for interest rates, you may see some ultra-low interests rates -- even as low as a 1% start rate.   But if something appears to be "too good to be true", it well may be.  The term "Let the Buyer Beware" is a philosophy that needs to be applied to the Payment Option ARM loan program -- make sure you understand the nuances of the program, and what effects they will have upon your financial picture. 

If you already understand the Pay Option ARM, then go direcly to the Option ARM calculator.

Anasazi Mortgage can originate this loan type, but we will take a cautious approach with you as you explore your options.

This loan program is an adjustable rate mortgage with a low initial monthly payment that will increase each year for the first five years.  It also offers other payment options to help you budget your monthly cash flow.

• Minimum Monthly Payment, using the start rate, but amortizing over a 30-year period
• Interest Only Payment based on a fully-indexed rate
• A 30-year Fully-Amortized Payment

Its low introductory start-rate allows you to make very low initial mortgage payments and low qualifying rates enable you to qualify for more home.

For instance, in calculating the monthly payment for a $420,000 mortgage:  The payment during the first five years starts by calculating the payment using the initial low introductory rate, usually 1 percent (to 2 percent).  That will be your minimum payment rate.  Each year the payment will increase 7.5 percent for the first five years.  But remember the payment rate is NOT your interest rate ("note rate").

The note rate is the interest rate the mortgage lender will charge you each month.  Some programs may use the "introductory rate" as the note rate for the first three months of the loan.  Then, after that introductory period, the note rate will then adjust to the index rate plus the margin rate.

At the end of Year 5 (EOY 5), if you have made only the minimum monthly payments, as required by the program, your current mortgage loan balance would be approximately $505,703.24 -- and this is assuming the index rate of the note has NOT changed.

You must then begin making fully amortized payments for the remaining 25 years, but remember your rate will be fluctuating monthly.  The rate can increase to the rate cap on the note, which may range from 9.95% - 11.95%, or more.  But, for a moment, assume that you have a remainder balance on your mortgage of $505,700, and we'll assume for a static rate of 7.785% (your beginning fully-indexed rate).  Your monthly payment, due in month 61, would now be $3,831.35 (not including taxes and insurance) -- QUITE A JUMP FROM YOUR MINIMUM PAYMENT due in month 60 of $1,804.07.

Another consideration is that at the end of the 5-year payment option period, the lender has a right to "re-cast the mortgage".   The lender will require that a new appraisal is done for your property, and that you are at the SAME loan-to-value (LTV), or lower than when you originated the loan than your current status.  What does this mean?

When we created this scenario, we assumed the loan was an 80% loan (to avoid mortgage insurance), with a 20% down payment.  If the loan was for an amount of $420,000, the original purchase price was $525,000.  The loan has a balance of $505,700;  $505,700 represents 80% of $632,125.  So, in order for your current loan not to have to be re-written (with possible mortgage insurance or a new second mortgage, your home's value must be greater than $632,125 at the end of the 5-year loan period.  This value growth seems pretty achievable, since it is less than 4% annual growth.

But, what would have happened had you chosen a 30-year fixed-rate mortgage with an interest-only option for the first 5 - 10 years?

The payment on an interest-only mortgage for the same 5-year period, assuming a fixed rate mortgage rate (on an interest-only loan) of 6.5%, would be $2,275.00/month.  Your mortgage loan balance would still be $420,000, but now instead of a remainder equity of approximately $126,425 (from the Option Payment ARM scenario above), your equity position, after 5 years, using an interest-only 30 year mortgage, would be about $212,000 greater !  At the beginning of year 6, your fully-amortized payment would increase to $2,835.87 -- less than the Option Payment ARM -- and you still have a guaranteed, fixed interest rate.

If you chose a fully-amortized 30-year fixed interest rate, your interest rate would probably be about 1/8% less than the interest-only option shown immediately above (6.375%), and your monthly principal and interest payment would be $2,620.25 -- for the 30-year period or as long as you have the house !! The mortgage balance at the end of Year 5 would be approximately $392,596.

The above is a detailed description of our analysis process, which we don't expect you to self-calculate, unless you really WANT to.  This discussion is meant to point out the dangers of "trying to get the best rate", without understanding its implications.

We are here to help, and encourage you to call us to discuss your particular loan scenario -- and let us do the detailed analyses, but just in case you still want to perform your own calculations, below are some additional helpful links.

Compare advantages of other Loan Programs

Some Option ARM Terminology

Deferred Interest:  The minimum payment option can help keep your monthly payments affordable.  If the minimum monthly payment is not sufficient to pay the monthly interest due, you will then have deferred interest. That is, the interest that was not paid will be added to the principal loan balance. Your loan balance increases each month. This is where the term negative amortized loan comes from. The balance increases, instead of decreases like in a normal loan. You can always avoid deferred interest by choosing the interest-only payment option.

Payment Options: With the option ARM, you generally have at least two fully amortized payment choices, leading to a quicker loan payoff. If you prefer to pay off your loan on schedule, you can make the fully amortized payment based on a thirty- or forty-year loan, or you can choose the fifteen-year payment option for the fastest equity buildup.

Option ARM loan programs might be right for you if you'd like to own your property only for a short time, and prefer affordability and flexibility in your monthly payment.  However, if you select the minimum payment option in the early years, you should be prepared for possible sudden increases in your monthly payments thereafter.

Types of Payment Options:

• Minimum Payment:  With the minimum payment option, your monthly payment is set for twelve months at your initial interest rate. After that, the payment changes annually.
• Interest-Only Payment:  With the interest-only payment option, you can avoid deferred interest, when the minimum payment is not enough to pay the monthly interest due. This payment option does not result in your principal reduction. The interest-only payment will change every month based on changes in the ARM index used to determine your fully indexed rate.
• Fully Amortized Fifteen-, Thirty- or Forty-year Payment:  Fully amortized means you have equal monthly payments for the entire term of the loan, and have a zero balance at the end. With fully amortized payments, you pay both principal and interest. Your payment is calculated each month based on the prior month's fully indexed rate, loan balance and remaining loan term.

Index plus Margin:  The index is the base rate used to determine your interest rate. Most people are familiar with the Prime rate, Treasury (T-Bill), LIBOR, COFI or COSI.  Option ARM programs are usually based on one of the following indexes:

• 1-Yr Treasury Average (12-month MTA)
• Monthly Treasury Average (MTA)
• London InterBank Offered Rate (LIBOR)
• 11th District Cost Of Funds Index (COFI)
• Cost of Savings Index (COSI)

The Margin is the number of percentage points (for example, 2.75) the lender adds to the index rate to calculate the ARM interest rate, or note rate, at each adjustment. The margin is fixed at the time the loan is funded.

The interest rate you will be charged is the index rate plus the margin.

The Payment Option ARM goes by several different names:  Option ARM, PayOption, Pick-a-Payment, Neg Am Variable, Negative Amortized loan.