Option ARMs Gaining Popularity in Florida

Homeowners who don’t want to be locked into a high monthly payment can take solace in the fact that… well, they don’t have to.

There’s a new type of adjustable-rate mortgage that is gaining popularity — the Option ARM. Not only does the mortgage rate adjust over a pre-determined period, this loan allows people to choose from an array of options how much to pay each month. Depending on who you ask, it’s either a godsend or a complete disaster.

Option ARMs operate like typical adjustable-rate mortgages, in that the mortgage rates change, according to a predetermined index and time frame. The option, of course, refers to the homeowner’s choice of payment. The option ARM allows the homeowner choose each month how much he or she wants to pay:

• A minimum payment at a reduced interest rate that defers part of the principal and interest.
• The interest-only portion of the monthly payment.
• The amount amortized as a 30-year loan.
• The amount amortized as a 15-year loan.

Sue Pierce, a loan officer and underwriter for Integrity Home Loans, Inc., in Melbourne, used an option ARM herself to finance the recent purchase of her Rockledge home. She plans to make the payments designed to pay off the loan in 15 years, but during months when commissions are low — or she has other expenses — she has the lower options to fall back on.

“It can be a great product, but you have to understand exactly what you’re getting into,” she said.

It’s not just private citizens who are jumping on this bandwagon. Investors can limit their monthly expenses through an option ARM and still come out ahead, as long as the property appreciates. Buyers across Florida who are just starting out in their careers and confident of increases in income can use it to get through the early years of a mortgage.

How much does it really cost?

Here is a look at the typical options for the monthly payment, with some sample numbers attached. Let’s assume you have a $200,000 mortgage with 6.5 percent interest on the nonminimum options. The mortgage borrower could choose each month whether to pay:

• Minimum: $350. The payment is calculated on about a 2 percent interest rate.
• Interest-only: $1,083. This is the payment a lender usually uses to qualify the buyers. If they can’t afford that payment, they probably won’t get the loan.
• 30-year: $1,264.
• 15-year: $1,742.

Homeowners with option ARMs will receive statements every month with the various options outlined because the numbers won’t be the same from month to month. It’s the first option of the four that has some experts worried, and brings up that ugly “negative amortization” possibility. It means owing more than the asset is worth to begin with, and happens with option ARMs if the buyer chooses minimum payments routinely.

In other words, interest is deferred, and no principal is paid off, so eventually, the buyer owes interest on the earlier, unpaid interest, as well as the entire loan amount.

Thus, discipline is extremely important. People such as Pierce, who are paid by commission, and small-business owners whose income can fluctuate, are prime candidates for the loan, said Holden Lewis, who covers mortgages for online service Bankrate.com.

“When the money isn’t coming in that month, they can make the minimum payment,” Lewis said. “They just have to have the discipline to catch up when the money is there. In the case of salespeople and small-business owners, they do have that self-discipline. That’s why they can succeed in those fields.”

Consumers who don’t need the cushion of the low-payment option need to examine whether the possibility of negative amortization and rising Florida mortgage rates are worth the risk. Bobbie Dyer, Wells Fargo manager for Brevard County, receives calls from borrowers who have seen a low rate offered or received an advertisement for a 2 percent mortgage. Those usually are option ARMs, and she is quick to point out the low rate often lasts only for the first month.

“They’re going to be in for major payment shock,” said Dyer, who suggests buyers consider a hybrid ARM, an option which locks in an interest rate for a period of time (usually three, five or seven years), instead. Wells Fargo does not offer this option, but some competing lenders, such as Washington Mutual, have a large amount of their capital invested in option ARMs. Despite the risks, they remain incredibly popular with their promise of low payments.

Dyer points out that negative amortization can happen more quickly than most people realize. For example, if a buyer bought a $200,000 house and put down 5 percent, and then made just the minimum payments, he or she would owe more than the original purchase price in just 20 months. She recommends that mortgage applicants visit multiple lenders, consider more than one type of mortgage, and ask for good-faith estimates.

In the end, the key is to understand the advantages of option ARMs, and choose the mortgage only for the right reasons. Make sure it is the right move for you and that you understand why you are applying for it. The market is also shifting in favor of buyers. If you find the right deal, you might be able to swing a Florida home loan that encompasses a lot less risk.