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Module 3
Preparing for Home Ownership
Types of Home Loans
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Option Adjustable Rate Mortgages (Option ARM)

What is an Option ARM?
Option ARM loans are one type of adjustable rate mortgage. Option ARMs are innovative loan programs designed to provide greater payment flexibility than other loan types. As with all ARM loans, your interest rate moves according to the interest rate index to which it is associated. That is an obvious benefit when overall industry interest rates and your associated index are falling, but during rising rate markets, you need to pay closer attention to an ARM loan. As its name suggests, an Option ARM offers you a choice of monthly payment options to help provide you with the financial flexibility to manage your payments in rising rate markets and to take advantage of falling interest rates.

Comparison to Traditional Fixed Rate
An Option ARM is very different from a traditional, fixed-rate, amortizing home loan. A fixed-rate, amortizing loan requires monthly payments which consist of both payment of the interest you owe (based on the interest rate on the loan) and repayment of the principal borrowed. This is known as an amortizing payment. As you make these monthly payments, the principal balance you owe goes down.

Negative Amortization
An Option ARM is a monthly adjustable rate mortgage. The interest rate you owe can change monthly — either up or down. With most products in the industry, the minimum monthly payment you are required to pay generally changes only once a year. If your interest rate increases in a given month, but you don’t increase the amount of your monthly payment, then it is likely that the minimum monthly payment will not be enough to pay all the interest due (let alone any principal) for that month. If this occurs, the portion of interest due which you did not fully pay is added to the principal balance which then goes up. This means that your equity in your home decreases due to what is known as negative amortization.

Monthly Payment Options
An Option ARM is designed to provide you with the ability to manage your monthly payment each month by offering up to four monthly payment options:

PAYMENT OPTION 1
Minimum Payment		 PAYMENT OPTION 2
Interest-Only Payment		 PAYMENT OPTION 3
Amortized Payment
(Based on the scheduled term of 30 or 40 years, if a choice is offered by the lender)		 PAYMENT OPTION 4
15-Year Amortized Payment

Option ARMs: Benefits and Risks
There are many benefits associated with this type of flexibility, and many informed borrowers find the program meets their financial needs. There are also risks associated with these programs, especially during a period when interest rates are rising and/or property values are leveling off or falling. The keys to realizing those benefits and safeguarding against those risks are having a clear understanding of how the various payment options work and actively managing your home loan account on a monthly basis.

For More Information
For more information on Option ARMs, please click here.
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