Option ARM Pitfalls
If you are looking for a loan in which you can select how much your monthly payment will be, then option ARM loans may be the right choice for you. However, the benefit of flexibility that these loans provide comes with some hidden aspects you should be well-aware of.
Option ARM Loans Disadvantages
To start with, in order to build equity you need to make amortizing payments which are relatively bigger. However, with option ARM loans borrowers generally choose to make lower payments, and at the end of the day experience what is known as negative amortization. This means that due to the smaller payment which cannot cover the interest you owe the outstanding balance of your loan increases.
Another thing is that even if you select to make smaller monthly payments, you will not be able to stick to them till the end of the loan's term. After a particular time period your lender will recast the loan. This can be done also when you owe too much on the loan, which is caused by the negative amortization. As a result, your monthly will drastically rise since the loan will be put on track so that it is fully amortized over the remaining term. You may face payment shock and have quite a headache, if you have not included this increase in your budget.
Consider the following scenario. You select to make the minimum monthly payments and your loan is recast, your monthly payments rise. You are not able to cover them. As a result you decide to sell your home to cover the loan. But, the bad news is that you still have to add up some money, because your loan balance has increased due to the negative amortization and now the value of your home is not enough to cover it.
As you can see, option ARMs can represent quite a risk for the borrowers if not used wisely. If you still have to use an option ARM loan, see whether it is really worth doing so. These loans are appropriate for clients who just need flexibility but have financial stability.
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