An Option Arm Anyone?

In the previous sizzling housing market many buyers got an Option Arm without really understanding it. This was a popular loan product because it was misunderstood. Many loan officers would tell their clients that they can buy a $500,000 house, even though they could not realistically afford it, and pay a monthly mortgage of $2,000 excluding taxes and insurance (taxes and insurance was usually omitted by the loan officer to make their payment seem really low). In theory it all sounded good--too good to be true as many homeowners found out.

For many, the ability to live in a home that they would otherwise never afford was a dream come true. This was their dream home and this loan made it possible for them to live in it, at least for a short time. In order for a typical homebuyer to get an option arm the lenders usually required a 5-10% downpayment, good credit score (no less than 620), and good credit history. As long as you met these conditions you were golden for an option arm.

Many loan officers offered these type of loans to their clients when they themselves did not really understand the loan program. First of all they only explained the initial interest rate of 1% and did not bother to explain that this rate was fixed only for the first couple of months and later would change on a monthly basis.

This loan program also gave the homebuyers several payment options. They could pay the fully amortized payment, principal plus interest, interest only payments, just interest, and the minimum payment, less than interest. Which one would you choose? I thought so!

Most homeowners would only make the required minimum payment, which by the way is not the minimum it is less than the minimum payment, therefore causing their loan to be negatively amortized.

Usually at the end of the first year a homeowner would get a statement from the lender indicating their new payment for the coming year. This new payment was calculated on the new loan amount, which for the most part was more than what they initially paid.

Another important factor in an option arm is the margin. The margin was crucial to this type of loan because the way that the lender calculated your real interest rate was by adding the margin to the current libor index (MARGIN + LIBOR). This number was usually in the high 7's or 8's. And the higher the margin for the lender the more money the loan officer made!