What is an Option ARM Loan?

An adjustable-rate mortgage has flexible mortgage payment options that help you to manage your monthly cash flow better. Its low introductory start rate allows for a low initial mortgage payment and low qualifying rates that enable you to qualify for more home.

The minimum payment option can help keep your monthly payments affordable. If the minimum monthly payment is not sufficient to pay the monthly interest, you can avoid deferred interest by choosing the interest-only payment option.

With the Option ARM, you 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 a fully amortized payment based on a 30-year loan, or you can choose the 15-year payment option for the fastest equity build-up.

You can also make additional principal payments which reduce the amount you need to pay in later months.

Option ARM loan programs are 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 after that.

Four major types of payment choices:

1. Minimum Payment

With the minimum payment option, your monthly payment is set for 12 months at your initial interest rate. After, the payment changes annually, and a payment cap limits how much it can increase or decrease each year.

If you make the minimum payment after the end of your initial interest rate period, it may not be enough to pay from the previous month. Thus, the unpaid interest will be added to the principal balance you owe (will be deferred).

2. Interest-Only Payment

With the interest-only payment option, you can avoid deferred interest. The interest-only payment option, however, is not available if the interest-only payment would be less than the minimum payment. Please note, that this payment option does not result in your principal reduction.

The interest-only payment may change every month based on changes in the ARM index used to determine your fully indexed rate.

3. Fully Amortizing 30-Year Payment

With fully amortizing payments, you pay both principal and interest and keep your loan on schedule. Your payment is calculated each month based on the prior month's fully indexed rate, loan balance, and remaining loan term.

4. Fully Amortizing 15-Year Payment

If you prefer to put your loan on an accelerated schedule and can afford higher monthly payments, the 15-year payment option allows you to repay your loan twice as faster and save more than half the total interest costs of a 30-year loan.

Please note, that this payment option is offered only on the 30-year (or 40-year) term. It will cease to be an option when the loan has been paid to its 16th year.
These options should be clearly marked on your loan statement, so it is very easy to figure out how much you should pay each month. Just enter the correct amount in the payment coupon section of your statement.

Option ARM loan programs are becoming more and more popular today, and there are many variations of this innovative home financing product on the market: PayOption ARM, Pick-A-Payment Loan, 1 Month Option ARM, CashFlow Option Loan, LIBOR (or 12-MAT) Pay Option Loan, etc. If you are thinking about applying for an option ARM, it is important to shop carefully and investigate several loan products, to find the one best for you.

Option ARM loan programs may vary in the initial rate, negative amortization and lifetime caps, ARM index, or optional features, however, when comparing one option ARM with another, pay close attention to the margin and the fully indexed rate. Keep in mind that the initial interest rate holds only for the 1st month.

Gretchen Wegrich

Gretchen Wegrich is an editor at Lender411. She specializes in mortgage basics, personal finance and green living. She graduated with a bachelor's degree in writing from University of California, San Diego and previously worked at the Santa Cruz Sentinel. Contact her at gretchen@lender411com.