This article looks at the advantages and disadvantages of a payment option adjustable rate mortgage. A payment option ARM home loan isn’t for everyone, but under certain circumstances there can be some advantages. There are also other types of adjustable rate mortgages that should be considered. Before looking at the risks and advantages, it’s important to understand what a payment option adjustable rate mortgage is.
What is a Monthly Payment Option Adjustable Rate Mortgage?
The payment option ARM allows the homeowner various choices each month on how they want their payment applied to their home loan. Each payment option has varying affects on the how the principal is paid, as well as how the interest is applied to the loan. The homeowner can choose one type of payment one month and a different type of payment the next month. There are generally three payment choices:
- principal and interest
- interest only
- minimum payment
A principal and interest payment choice is like a traditional fixed loan where the interest is paid along with the principal. An interest only pays the interest, but not the principal. The minimum payment is an amount that is set as the minimum amount that can be paid each month. The minimum payment is an amount that is less than principal/interest and interest only options.
Advantages and Disadvantages of an Adjustable Rate Mortgage
The main advantage of an adjustable rate mortgage is the monthly mortgage payments are lower than a traditional fixed rate mortgage at the beginning of the loan. If the homeowners plans on staying in the home for a short period of time, like two to three years, an ARM may be a good option. If the homeowners will realize an increase in income in the near future, an ARM may also be a good option.
If the mortgage holder is on a fixed income and is planning on keeping the home for a long period of time, an adjustable rate mortgage may not be a good option. The payments in the early part of the loan will be less than a traditional fixed mortgage, but the homeowner runs the risk of substantially higher payments in the future.
Minimum Payment Option and Negative Amortization
With a payment option ARM, the interest rate is generally very low for the first few months. After a few months the interest rate usually reflects that of a traditional mortgage rate. If the homeowner uses the minimum payment option, the amount of unpaid interest will be added to the principal of the loan. The increase in principal is known as negative amortization.
If the mortgage holder continues to use the minimum payment option, the principal will continue to increase creating negative amortization. Generally after five years, the monthly payments are recalculated. A higher principal, as a result of negative amortization, will result in higher monthly payments when the loan is recalculated.
Resource:
federalreserve.gov
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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