A payment-option adjustable-rate mortgage (ARM) is a type of mortgage that adjusts monthly and gives borrowers the flexibility to select from various payment choices. These options may include just paying the interest or a combination of principal and interest.
However, some of these choices allow for a minimum payment that might not fully cover the monthly interest, leading to an increase in the total loan amount over time. While payment-option ARMs provide flexibility, they also come with risks, especially if the loan balance grows and repayment becomes difficult.
Understanding about Payment Option ARM
A fixed-rate mortgage payment usually consists of two parts: a portion goes towards the principal and the other towards interest. The principal is the initial amount you borrowed, while the interest is the fee charged by the lender based on the loan’s interest rate.
When you’re paying back your mortgage, if you skip paying the principal, you’re not reducing the debt you took out. If you don’t cover all the monthly interest, the unpaid amount gets tacked onto your loan balance, which means you end up owing more—this is known as negative amortization. For this explanation, we’re leaving out property taxes and homeowners’ insurance.
Risks of Payment-option ARM
Payment-option ARMs come with some risks, especially if you opt for interest-only payments, as this doesn’t lower your principal balance. Additionally, if you decide to make just the minimum payment, it likely won’t cover the full monthly interest. This means any unpaid interest gets tacked onto your loan balance, leading to an increase in your overall debt.
Conclusion
A payment-option ARM is a kind of adjustable-rate mortgage that gives borrowers the flexibility to select from several monthly payment choices. These choices typically include a payment that covers both principal and interest, which helps lower the total amount owed. Alternatively, there are options for interest-only payments and a minimum payment, which doesn’t fully cover the monthly interest. It’s important to note that neither the interest-only nor the minimum payment options decrease the loan balance, and paying less than the interest can actually lead to an increase in the loan amount.