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| NAME: Carol |
AGE: 39 |
Occupation:
Executive Assistant | |
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| Personal Stories |
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The lender also explained how an Option ARM is different than a regular ARM. With an Option ARM, you usually have a choice of payment options that you can make each month: a minimum payment, an interest-only payment, or a fully amortized payment.
Payment Option |
Definition |
Minimum Payment |
A minimum payment is based on a low interest rate, like 1% or 2%. This interest rate is usually lower than the loan’s true interest rate. Paying only the minimum payment will cause the amount of interest you owe, but do not pay, to be added to the principal of the loan. This will increase the overall amount you owe, your future monthly payment amounts, and increase the amount of interest you will pay over the life of the loan. |
Interest Only Payment |
An interest-only payment means you pay all of the interest due that month, but pay nothing towards the loan principal, so your loan balance doesn’t go down or up. |
Fully Amortized Payment |
A fully amortized payment means paying back both interest and principal due each month. This will reduce the loan balance based on a 15, 30 or 40 year payment schedule. Because you are paying back both principal and interest with your payment, your loan balance will go down over time. | What I liked about the Option ARM was that it would allow me to choose what payment to make each month based on the loan pay-off or amortization schedule. The lender explained that with an Option ARM, I could make smaller payments (such as the minimum payment or interest only payment) and invest the rest of my money for long-term goals such as my retirement or my children’s college education. But he also reinforced the importance of knowing what happens when you make only the minimum payment. When you make only the minimum payment you’re not paying all of the interest due for that month, and the interest you didn’t pay is added to the loan balance, causing the amount you owe to actually get higher, not lower! This is called negative amortization. So, in a nutshell, being able to make a low minimum payment can be nice in case you're short on cash in any particular month, but there can be serious consequences (such as causing your minimum payment to increase significantly down the road, sometimes by as much as 50%) if you just make the minimum payments all the time. While the Option ARM makes sense for my friend whose income changes through the year, and who needs the flexibility to choose what payment she makes, I have a different situation. My salary is pretty stable and I didn’t like the fact that my monthly payment could possibly increase every month with an Option ARM loan. I really like the security of knowing my payments won’t change over time. My lender explained that the Option ARM loan is a good financial tool for borrowers with 'non-traditional income' like my friend. However, he also stated how important it is to understand the mechanics of the Option ARM loan before choosing it, as it really requires you to "manage" your home loan account each month. In the end I felt more comfortable with the idea of a 30-year fixed rate home loan. I have enough change in my life right now without having to worry about my loan payments changing, too. More
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