Over the
last 18 months, I’ve had the opportunity to meet and get to know Clint Windler,
owner and Sr. Mortgage Consultant of American Signature Mortgage. Recently, Clint assisted one of my clients –
an investor purchasing a town home – in arranging his mortgage. At the closing, I was introduced to a type of
loan I’d not encountered before, a “pay option ARM.” Recently I sat down with Clint to ask a few
questions and learn more about this kind of financing.
CE: Clint, what
exactly is a “pay option ARM”?
CW: A Pay Option
ARM (or sometimes they’re called Pick-A-Payment loan, Flex-Pay Option or a Neg
Am Loan) is a loan that allows the borrower to choose from four different
payment options each month. The first
option is a minimum payment, this payment is calculated on a “minimum rate”
which is determined at time of application and is typically 1-3% depending on
the specific characteristics of the loan scenario and borrower. If you pay the minimum payment, you will
defer the difference in interest between your minimum rate and your fully
indexed rate or actual rate for that month. This will result in what is called a negative amortization. The second is an interest only payment which
would cover the cost of the interest that has occurred within that month. Making this payment will avoid deferred
interest, but will not reduce the principal balance. The last two options are a 30 year fully
amortizing or a 15 year fully amortizing, and in some cases a 40 year fully
amortizing term is available. Each of
these payments is calculated based on the fully indexed interest rate, the
balance of the loan and the term left on the loan. Either one covers the interest due, reduces
the principle and, if paid every month, retires the loan on a 30 or 15 year
schedule.
CE: OK. I get the big picture, but can you give me an
example of how a loan might work?
CW: Sure. Take, for example, the investor you and I
were working with recently on the town home purchase. That pick-a-payment loan had a loan amount of
$127,548. The fully indexed rate for the
first three years was 7.197% with a minimum rate of 2.5%. This particular scenario will have a monthly
mortgage statement which will break down how much principle you has been paid
as well as how much interest has both been paid and/or deferred. In a separate section you will find the
following four payment options which would look much like this:
Payment Options Option 1 Option 2 Option
3 Option 4
Interest
Due 764.97 764.97 764.97 764.97
Deferred
Interest -261.00 0 0 0
Principle
Paid 0 0 100.55 395.55
TOTAL PAYMENT 503.97 764.97 865.52 1,160.52
CE: What is the
“adjustable” part of the ARM? How often can
the rate adjust?
CW: As this loan
has increased in popularity so have the ways in which a borrower can customize
it to their own personal needs and risk levels. Originally this loan was offered only as a 1 month adjustable rate loan.
This meant that your fully indexed interest rate would adjust monthly against
the index
you and your mortgage professional “tied” your margin
to. In turn this would cause your
interest only and fully amortizing payments to fluctuate with the market as
well. Now, there are new Pay Option ARM
programs that have fixed rates for 3, 5 or even 7 year periods. These programs fix
the “actual” rate for the initial 3, 5 or 7 year period at which time the rate
would again adjust monthly against your chosen index.
has just added a Pick-A-Payment Loan that has a fixed rate, so it locks your “actual”
interest rate for the entire term of the loan.
The other
adjustment that this loan has is the adjustment of the minimum payment. Every 12 months the lender has the ability to
increase the minimum payment by as much as 7.5% of the payment amount. To show you what I mean, let’s refer back to
our example loan. The minimum payment of
$503.97 could adjust to a payment of $541.77 after the first 12 months.
CE: Will I have to pay a higher interest rate to
get this program as opposed to a conventional loan?
CW: No. You
will not automatically pay a higher rate because of the nature of the program;
but because these are loans that are tied to a moving index your rate could be
higher or lower than the current conventional fixed rates depending on the
current market conditions and which index
you choose. Another factor that will
determine your rate is of course your margin. Your margin is determined by the details of
your loan request. For example: loan to
value, stated income vs. verified income, property type and/or use and so on.
CE: Do I have to have a credit score of over 750
to qualify for this program.
CW: No. I’ve gotten loans approved with scores in the low to mid 600’s.
CE: Are you
recommending this loan to all of your customers? Who is best suited for this type of mortgage?
CW: Pay Option
ARMs are great for many borrowers but are not for everyone. One of the best
uses is for borrowers who own rental property. The flexibility and minimum
payments can be used to maximize cash flow from the property and or to off set
additional expenses such as repairs or vacancies. It is also a great option for borrowers who
have irregular income such as self employed borrowers, individuals who work in
a seasonal business, commissioned borrowers or people who receive part of their
income as bonuses. Any of these
individuals could benefit from being able to choose the lower interest only or
minimum payment during months of lower income and then revert to one of the
fully amortized options when their income has again increased.
But, there
are some downsides to this kind of financing. One of them is the possibility of negative amortization of your mortgage
over time. This, in simple terms, is adding debt to your property and will happen
if you always pay the lowest payment, as it is usually a “minimum” interest
rate of 1-3%. The difference between your fully amortized rate and the lower “minimum”
rate will be added to the principle amount of your mortgage. People who get this loan solely as a way to
obtain the low minimum payment could find them selves in trouble as the
deferred interest adds up and causes the loan to “recast.” Once the principle balance reaches 110-125%
of the original balance the lender has the right to recast the loan and remove
the minimum payment option, forcing the borrower to pay the interest only
payment or one of the fully amortized payments figured at the new principle balance
owed. If structured and used correctly
this rarely happens.
CE: So, this kind
of financing isn’t for everyone, but it may be just right for certain people
and situations.
CW: Exactly. The best way to put a
pay option arm mortgage to work is to talk with one of our experienced mortgage
consultants who will design a personalized program just for you based on your
own individual or family's goals, income, monthly bills and future housing or
investment property plans. The
information I’ve shared with you here is really just a brief overview of the pick-a-payment
loan. There is much to be discussed in
more detail with a lending professional before you apply to obtain this or any
other type of financing.
