How about a mortgage with an interest rate as low as one or two percent? Wow! The
payment on an adjustable rate mortgage sounds great, but as the old
saying goes, if it sounds too good to be true, it probably is.
At the time this article was written, the federal government borrowed money at 4.64% APY for a month term, so an individual homeowner borrower money at a lower rate than our government? The simple answer is no. Can this still a good loan? Yes, for a select few who understand how it works. The rest of this article, the basic questions you should ask when considering the negative amortization loan usually referred to as an option ARM.
Let's first define some key terms.
Payment: the percentage used to calculate your minimum monthly payment. It is usually the artificially low rate of 1 to 3% (or a rate equal to or less than the One Year T-Bill rate: currently 5.23%) that is advertised by your lender. Remember that the government borrows money to what is called the "risk-free" rate called and everyone pays a higher rate that a "risk premium" reflects.
Index: The particular statistical indicator associated with your loan. This value may rise or fall over time and this in turn can increase or decrease the interest rate on your loan. Some examples of indexes for the Option ARM, the monthly Treasury Average (MTA) or the cost of Funds Index (COFI).
Index Value: This is the numerical value of your index today. You can check in the Wall Street Journal or other similar publication at any time on your own. The value of the index
Margin: This is a numeric value that does not change over time. It is important to note that your margin is negotiable. A big mistake to make in getting an option ARM borrowers in default to negotiate the margin.
Fully indexed rate: Now we finally get to the real interest rate you pay on your loan. The index value plus the margin equals your fully indexed rate. This percentage is 7%, 8% or higher.
Amortization Period: The actual number of years it will take to pay the loan in full.
Negative Amortization: The increase in mortgage debt due to the difference between the fully indexed rate and payment rate (ie loans = $ 300k, payment rate = 1%, fully indexed rate = 7%, then at the end of a year would NEG AM = $ 300k * (7% - 1%) = $ 18k and your loan at the end of the year = $ 318k).
These are the basic conditions that must be understood to begin the risks and benefits of an option ARM estimate. There are also speed adjustment and payment caps that some extra protection for the borrower to offer. The Option ARM is an extreme way to make real estate and managing cash flow. Use Theoretically, the borrower making a return higher than the rate of negative amortization. If this is the case, then the Option ARM works well for that borrower. Another suitable fit for this type of loan is that a borrower will experience a dramatic increase their income in a few years and the monthly savings are more precious at this present date.
The sad reality is that some lenders market the Option ARM if that low, low payment rate is the actual interest rate and applicants flock to this form of financing without an understanding of the negative amortization. Even worse is the lack of awareness among the participants in the mortgage industry. Inherent to the Option is the ARM to the amount of negative amortization allowed predetermined limit. This period can be anywhere from 10% to 25% of the original loan balance. Notwithstanding any payment or rate caps, when the negative amortization increases the mortgage balance predetermined threshold then all bets are off. The borrower can not pay that low, low payment rate. The borrower will also no longer have the option to pay an interest-only payment. The borrower is then faced with having to pay a fully refundable. Payment on the fully indexed rate In a worse case scenario could result in an almost tripling of the minimum required payment before the end of the second year.
At the time this article was written, the federal government borrowed money at 4.64% APY for a month term, so an individual homeowner borrower money at a lower rate than our government? The simple answer is no. Can this still a good loan? Yes, for a select few who understand how it works. The rest of this article, the basic questions you should ask when considering the negative amortization loan usually referred to as an option ARM.
Let's first define some key terms.
Payment: the percentage used to calculate your minimum monthly payment. It is usually the artificially low rate of 1 to 3% (or a rate equal to or less than the One Year T-Bill rate: currently 5.23%) that is advertised by your lender. Remember that the government borrows money to what is called the "risk-free" rate called and everyone pays a higher rate that a "risk premium" reflects.
Index: The particular statistical indicator associated with your loan. This value may rise or fall over time and this in turn can increase or decrease the interest rate on your loan. Some examples of indexes for the Option ARM, the monthly Treasury Average (MTA) or the cost of Funds Index (COFI).
Index Value: This is the numerical value of your index today. You can check in the Wall Street Journal or other similar publication at any time on your own. The value of the index
Margin: This is a numeric value that does not change over time. It is important to note that your margin is negotiable. A big mistake to make in getting an option ARM borrowers in default to negotiate the margin.
Fully indexed rate: Now we finally get to the real interest rate you pay on your loan. The index value plus the margin equals your fully indexed rate. This percentage is 7%, 8% or higher.
Amortization Period: The actual number of years it will take to pay the loan in full.
Negative Amortization: The increase in mortgage debt due to the difference between the fully indexed rate and payment rate (ie loans = $ 300k, payment rate = 1%, fully indexed rate = 7%, then at the end of a year would NEG AM = $ 300k * (7% - 1%) = $ 18k and your loan at the end of the year = $ 318k).
These are the basic conditions that must be understood to begin the risks and benefits of an option ARM estimate. There are also speed adjustment and payment caps that some extra protection for the borrower to offer. The Option ARM is an extreme way to make real estate and managing cash flow. Use Theoretically, the borrower making a return higher than the rate of negative amortization. If this is the case, then the Option ARM works well for that borrower. Another suitable fit for this type of loan is that a borrower will experience a dramatic increase their income in a few years and the monthly savings are more precious at this present date.
The sad reality is that some lenders market the Option ARM if that low, low payment rate is the actual interest rate and applicants flock to this form of financing without an understanding of the negative amortization. Even worse is the lack of awareness among the participants in the mortgage industry. Inherent to the Option is the ARM to the amount of negative amortization allowed predetermined limit. This period can be anywhere from 10% to 25% of the original loan balance. Notwithstanding any payment or rate caps, when the negative amortization increases the mortgage balance predetermined threshold then all bets are off. The borrower can not pay that low, low payment rate. The borrower will also no longer have the option to pay an interest-only payment. The borrower is then faced with having to pay a fully refundable. Payment on the fully indexed rate In a worse case scenario could result in an almost tripling of the minimum required payment before the end of the second year.
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