Understanding the Option ARM
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Choose the mortgage payment you are most comfortable with.  Our pick a payment home loan allows you to take control of and pay:  1) your monthly minimum payment, 2) interest-only, 3) 30 year fully amortized interest and principal payment, 4) or your fully amortized 15 year option. 
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MTA, COFI option ARM calculator
SECURE option ARM- 5 year

 

 

Typical Option ARM program

How the Minimum Payment Changes

Typically, your Minimum Payment will increase each year for the first few years you have an Option ARM. This is because the first year's Minimum Payment is calculated using your beginning interest rate ("start rate"), which is usually lower than the Fully Indexed Rate (the index value plus the margin) that applies to your loan after the end of the introductory period.

In most years, your Minimum Payment can only change up or down by 7.5% per year, because of the 7.5% "Payment Change Cap."

There are two circumstances when your Minimum Payment can change by more than 7.5%:

  • After every fifth year
  • If, because of deferred interest, the unpaid principal balance you owe increases to more than 125% (110% in New York) of the amount you originally borrowed

In these situations, your loan is recalculated ("recast") based on the amount you owe at the time. Recasting our loan keeps you on the original schedule for paying it off. When your loan is recast, for example after five years or 60 months, your minimum payment can increase or decrease by more than 7.5%.

When your loan is recast, the calculation is based on:

  • How much you still owe (the "outstanding principal balance")
  • How much time is left on your loan (the remaining term)
  • The interest rate (the "Full Indexed Rate", which is the index value plus the margin for your loan)

After the recast, the Payment Change Cap goes back into effect from that point on, your Minimum Payment can only go up or down by 7.5% per year until the next time your loan is recast.

Even when your loan is recast the Lifetime Interest Rate Cap stays in effect. The Lifetime Interest Rate Cap is the maximum level to which your interest rate can rise, and is set at the beginning of your loan.

The Minimum Payment and Deferred Interest

Before you make the Minimum Payment, it's important to understand deferred interest. Every month, your home loan is charged interest, based on the remaining principal balance and the applicable interest rate.

With the Option ARM, one of your payment options is an "Interest Only" Payment, which covers the amount of Interest due that month. When the Minimum Payment is less than interest only Payment, the Minimum Payment will not be enough to pay all of the interest charged on your loan for the previous month and it will not pay down any of the principal balance. If you just make the Minimum Payment, the unpaid interest will be deferred. That is, it will be added to the principal balance you owe. This is called "negative amortization", and it means that the amount you owe increases and you will be charged additional interest at the rate of your loan on the new, larger principal balance.

Any time you defer interest, your loan statement will track and display it each month as unpaid interest. While deferred interest is added to your overall loan balance, you also can choose at any time to pay the amount down more quickly.

How the Minimum Payment May Change in the First Five Years

The two examples below show how the Minimum Payment may change in the first five years, as a result of a full 7.5% (shown as 1.075 in the example below) maximum annual payment increase. Remember, if the index is dropping, the maximum annual payment decrease is also capped at 7.5% of the Minimum Payment for the previous year. Examples are for loans of $180,000 and $460,000 with a 30-year term and a start rate of 1.25%.

Example 1

1-Month option ARM -12-MTA 30 year term
Loan amount= $180,000
Start rate = 1.250% (APR=3.596%)

Year 1 $599.85
Year 2 $644.84
Year 3 $693.20
Year 4 $745.19
Year 5 $801.08

Example 2

1-Month Option ARM 12-MTA 30-year term
Loan amount = $460,000
Start Rate = 1.250% (APR=3.596%)

Year 1 $1,532.96
Year 2 $1,647.00
Year 3 $1,771.53
Year 4 $1,904.39
Year 5 $2,047.22

These examples show what would happen if you had one of these loans and made only the Minimum Payment every month, if interest rates are rising, making only the Minimum Payment could lead to substantial deferred interest. This could cause your loan to be recast in the first five years, at which point your Minimum Payment could rise more than 7.5% or could lead to a significant change in your Minimum Payment when your loan is automatically recast after five years of monthly payments.

This fact sheet describes how the Minimum Payment works and how it can change. See the Option ARM Payment Options Fact Sheet for more information on other payment options.

Payment Options

Option 1: Minimum Payment

The Minimum Payment is the smallest amount of interest and, if applicable, principal, that you must pay each month. The minimum Payment may not be enough to pay all of the interest charged on your loan for the previous month and it may not be enough to pay all of the interest charged on your loan for the previous month and it may not pay down any of the principal balance. If you just make the Minimum Payment, the unpaid interest will be deferred, that is, it will be added to the principal balance you owe. This is called negative amortization, and it means that the amount you owe increases and you will be charged an additional interest at the rate on your loan on the new, larger principal balance.

  • Your Minimum Payment usually stays the same for 12 months at a time, unless your loan needs to be recast (see #5 below).
  • The Minimum Payment on your loan, which is fixed for your first 12 monthly payments, is initially based on the amount you borrow, the term you select for your loan and the interest rate (the start rate) specified in your commitment letter.
  • Every 12 months your Minimum Payment can change, it also can change if your loan needs to be recast.
  • In most years, your Minimum Payment can only increase or decreased by 7.5% per year from the amount of your previous year's Minimum Payment.
  • Every fifth year, or if your unpaid balance increases to more than 125% (110% in New York) of the amount you originally borrowed, your loan is recast, or recalculated to keep it on schedule. At the time your loan is recast your Minimum Payment can increase of decrease by more than 7.5%.
  • When you make the Minimum Payment, you may not be paying all the interest charged on your loan for the previous month. The interest you don't pay is called deferred interest and is added to the total amount you owe.
  • While your Minimum Payment usually stays the same for 12 months at a time, your actual interest rate will change monthly (after the end of your introductory period when you Start rate is in effect). This means that after your introductory period your monthly payment may not be enough to pay all of the interest charged for the previous month.

For more information on the Minimum Payment, please ask us for the Option ARM Minimum Payment Fact Sheet.

Option 2: Interest Only Payment

With this payment option, you pay only the interest charged on your loan for the previous month. By making an Interest Only Payment, you will avoid negative amortization but no portion of the payment will be applied to reduce the principal balance of your loan. Your Interest only payment may change from month to month based on changes in the index value used to determine your Fully Indexed Rate (the index value plus the margin).

Option 3: Full Principal and Interest Payment

(Based on the remaining schedule term of your loan)
With this payment option, you pay all of the interest charged on your loan for the previous month as well as enough principal to pay off your loan based on the remaining scheduled term of your loan. By making this payment each month, you ensure that all interest and principal are fully paid on schedule. Your Full Principle and Interest Payment may change from month to month based on changes in the Index value used to determine your Fully Indexed Rate (the index value plus the margin)

If you make a Full Principal and Interest Payment every month, you keep your loan on schedule.

Option 4: Full Principal and Interest Payment

(Based on a 15-year term)
This payment option is available only when your loan has a term of more than 15 years. This payment option is similar to a Full Principal and Interest Payment  but with a larger amount of principal paid each month. This amount includes all of the interest charged on your loan for the previous month plus principal to pay off your loan based on a 15-year term (instead of a 30 or 40 year term). Please note that unless you make this payment every month, your loan may still be outstanding for more than 15 years. This payment amount may change from month to month based on changes in the index value used to determine your Fully Indexed Rate (the index value plus the margin).

Choosing the 15- Year Full Payment puts your loan on an accelerated amortization schedule. Even if you've signed up for a 30- or 40 year term, you'll have the option of making a larger payment each month so that you will be able to pay off your loan before its scheduled maturity date. If you make a 15-Year Full Payment every month, you will pay off your loan in 15 years.

A Note on the Minimum Payment

The Minimum Payment is always the smallest amount that you must pay. Any payment option that would be less than the Minimum Payment in a particular month will not be available for that month.

The 7.5% Payment Change Cap

The Payment Change Cap limits the amount your Minimum Payment can increase and decrease in most years to 7.5% of the previous year's Minimum Payment. However, when your loan is recast, the Payment Change Cap does not apply and your Minimum Payment can go up or down by more than 7.5%. For more details on the Payment Change Cap, ask us for the Minimum Payment Fact Sheet.

The Lifetime Interest Rate Cap

All adjustable rate mortgages offer Lifetime Interest Rate Caps. With the Option ARM, your lifetime cap sets a maximum interest rate for your loan; your interest rate can never exceed it. Determined during your application process, your lifetime cap will remain unchanged for the life of your loan.

Other Items that May be Included with Each Payment Option

Each Month, the payment options available to you also may include an escrow payment for taxes, insurance and other escrowed items. In addition, if your loan is past due, your available payment option(s) will include past due amounts as well as any unpaid late charges. If you have elected to receive optional products (such as credit life or disability insurance), your available payment option(s) also will include the fees for these optional products.

Introductory Period

During the introductory period, the interest rate on your loan is calculated at a special start rate, which is usually lower than the Fully Indexed Rate (the index value plus the margin) This start rate remains in effect for a limited period of time; for example, for one month if you select the 1-month Option ARM or three months if you select the 3-month Option ARM. The use of a start rate and introductory period affect your loan in three ways:

  • The start rate is used to calculate the Minimum Payment that you are required to pay for the first 12 monthly payments. The Minimum Payment amount remains the same even when the start rate is no longer in effect and interest is computed on your loan at the Fully Indexed Rate.
  • After the introductory period, you are charged interest on your loan at the Fully Indexed Rate (the Index Value plus the margin). The amount of interest you are charged each month at the Fully Indexed Rate may be more or less than the amount charged at the start rate, depending on changes in the index value used to calculate your interest rate.
  • During the introductory period, only two payments options are available: the Minimum Payment, which covers all principal and interest due on your loan to amortize your loan based on the start rate, and the Full Principal and Interest Payment (based on a 15-year term). After the end of the introductory period, when interest is computed at the Fully Indexed Rate, other payment options may become available. If you only pay the Minimum Payment after the end of the introductory period, your loan may not amortize completely over the remaining scheduled term of your loan.
Contact your Choice Finance® Loan Officer for any questions and to help you with your application.

 

Secure Option ARM- 5 year

The typical program is broken down into 3 payment periods:

Option period- is the first 60 months (5 years) OR if the loan reaches the negative amortization cap. This Neg Am cap is reached when the next scheduled payment date would cause the principal balance to exceed 115% (110% in New York). The interest rate will not change during this period.

The 4 options of payment during this period are

  1. Interest only payment based on the original loan amount and a rate that is 3% below the note rate. This is called the Minimum Payment.
  2. Interest only payment calculated at the note rate based on the unpaid principal balance.
  3. A fully amortizing payment based on a 15 year term to maturity.
  4. A fully amortizing payment based on the actual remaining term to maturity.

These options are not available after 5 years or if the loan has reached it's amortization cap.

Interest only period- is until the 120th month. The principal balance will not be decreased by an interest only payment. The payment will cover the interest as it accrues each month.

Fully amortizing period- will remain in effect until the maturity of the loan. The monthly payment will be an amount sufficient to repay the unpaid principal balance at the then existing interest rate for the remaining term, in equal monthly installments.

After the first 60 months the monthly payment can change once every 6 months based on the index rate and the margin. The index on this program will most likely be based on the 6 month LIBOR, and the interest rate caps will most likely be 5/1/5. 5% after the first 60 months, then 1% every 6 months thereafter, and never higher than 5% above the initial note rate.

 

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