A payment-option ARM is an adjustable-rate mortgage that allows you to choose among several payment options each month. The options typically include the following:
With the minimum payment option, your monthly payment is set for 12 months at your initial interest rate. After that, 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, which usually holds only for the first 1 to 3 months, it may not be enough to pay all of the interest charged on your loan for the previous month and the unpaid interest will be added to the principal balance you owe (will be deferred).
With the interest-only payment option, you can avoid deferred interest, when the minimum payment is not enough to pay the monthly interest due. 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.
- 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.
- 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.
The interest rate on a payment-option ARM is typically very low for the first few months (for example, 2% for the first 1 to 3 months). After that, the interest rate usually rises to a rate closer to that of other mortgage loans.
Payment-option ARMs have a built-in recalculation period, usually every 5 years. At this point, your payment will be recalculated (lenders use the term recast) based on the remaining term of the loan. If you have a 30-year loan and you are at the end of year 5, your payment will be recalculated for the remaining 25 years. If your loan balance has increased because you have made only minimum payments, or if interest rates have risen faster than your payments, your payments will increase each time your loan is recast. At each recast, your new minimum payment will be a fully amortizing payment and any payment cap will not apply. This means that your monthly payment can increase a lot at each recast.
