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Other Mortgage Packages

Several new residential mortgage variants have been introduced on a national scale. Some of these (like the growing equity mortgage) have come and gone. Others have only limited availability.

Payment Option ARM

A new, popular type of mortgage was introduced in 2004 called the Payment Option ARM. It is also called a Pay Option ARM, FlexArm™, Recast ARM, and Option ARM. Your lender may have another name entirely.

A payment option ARM is a hybrid between a GPM and a conventional ARM. It starts with a very low payment rate that is fixed for the first year, hike a GPM, this low payment may not be large enough to cover the interest on your loan, and there will be negative amortization. Unlike a GPM, which is a fixed-rate mortgage, the payment option ARM's interest rate goes up and down according to its index plus margin. With a GPM, the interest shortfall is small and predictable, but with a payment option ARM, the negative amortization may be quite substantial.

The minimum payment goes up every year for five years by 7.5 percent just like a GPM payment. At the end of five years, the payment is “recast” so the loan is fully amortized in the remaining 25 years.

The payment option ARM is so named because the borrower has the option to make payments in three different amounts. Each month they will receive an invoice from their lender that shows:

• The minimum payment they can make

• The payment that covers the interest so there is no negative amortization

• The payment that includes enough principal repayment to amortize the loan in 30 years

In what situations is the payment option ARM the best choice of loan? This loan is great for investors or consumers who do not plan to own the property more than a few years and will sell it before the payment increases at the end of five years.

It is also a good choice for someone whose income varies widely from month to month, such as a commissioned salesperson or self-employed business owner. In months when their earnings are low, they can make the minimum payment. In months when their earnings are high, they can make the fully amortizing payment. By making large payments several times a year, they avoid a large payment shock at the end of live years.

Advantages. Because the payment option ARM starts with such a low payment rate, it is much more affordable in the early years than a traditional fixed-rate mortgage and even more affordable than an interest-only loan. The initial payment of the payment option ARM may be as little as 50 percent of what would be required for a traditional fixed-rate loan, and you could qualify with about 30 percent less income.

Disadvantages. Because the payment option ARM is an ARM loan, it has all of the advantages and disadvantages of an ARM. Payment shock at the end of five years (or even sooner) is a distinct possibility. Some of the payment option ARMS (some state law s) limit negative amortization to 10 percent of the original loan amount. If your loan balance reaches 110 percent of the original loan, your minimum payment would be the “interest only" payment. At the end of five years, your recast payment w ill probably be more than twice as much as the starting payment w as.

 
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