|5 ways to assess risk of your option ARM
|By Holden Lewis Bankrate.com
A mortgage called the option ARM offers a tantalizing possibility: The minimum payment is so low that you owe more on the house at the end of the month than at the beginning.
If you read Norton Juster's "The Phantom Tollbooth"
as a kid, you're familiar with the concept. As the characters dine
on a concoction called "subtraction soup," they become
hungrier by the spoonful. They feel ravenous at the conclusion of
An option ARM is like subtraction soup, except that a steady diet
of minimum payments can result in a feeling of homelessness instead
of hunger. To pile on the alarming rhetoric, a recent cover story
in BusinessWeek dubbed the option ARMs "nightmare mortgages"
and called them "toxic" and "deceptive."
Payment option adjustable-rate mortgages are appropriate for some
borrowers in certain circumstances, and they're dangerous for other
|If you have an option ARM, there are ways to assess
your risk and steps to take. Here are some risk factors
to watch for:
1. You don't
understand how an option ARM works, but you have one anyway.
Mitch Ohlbaum, president of Legend Mortgage in Los Angeles, bemusedly
pages through the BusinessWeek article that calls option ARMs nightmare
"They're nightmares to the extent that people don't have them explained," Ohlbaum says. "I get calls all the time from people who say, 'I took this loan, I didn't understand it, my rate keeps going up. No one explained it to me."
Option ARMs are hard to describe. Mortgages lie on a spectrum from the fairly simple to the sublimely complex, like the math taught from first grade through college. Fixed-rate loans are like basic arithmetic. Adjustable-rate mortgages are like algebra. Option ARMs are like calculus. Plenty of homeowners are furrowing their brows in calculus class when they should be memorizing their multiplication tables.
An option ARM is an adjustable-rate mortgage that
gives the borrower four choices of a payment each month. The borrower
can pay the amount necessary to pay the loan off in 15 years or
in 30 years. The borrower can pay only the interest charged in the
previous month. Or the borrower can make a minimum payment that
doesn't even cover the interest, so that the loan balance increases.
Most option ARMs have absurdly low introductory rates, sometimes below 2 percent, that last just a month. Then they rise. And rise. The rate changes each month, but the minimum required monthly payment changes only once a year.