Here is an article from CountryWide that explains an option arm loan very well. I feel these loans are confusing to borrowers and usually advise client towards at least an interest only. These loans are in my opinion what fueled the mortgage problems we are currently seeing.
This is how it works: Each month, you will receive an easy to read loan statement that lets you choose the payment amount that best suits your current financial needs. Pay the minimum amount to free up funds for other uses, or make larger payments for faster equity build up.
Loan Features:
A fixed interest rate for an initial 1-month period; thereafter the interest rate may change monthly
A minimum payment amount that adjusts on an annual basis subject to a 7.5% payment change cap
A 7.5% payment change cap limits how much the minimum monthly payment can increase or decrease from the previous minimum payment, except on the fifth year of your loan and every five years thereafter*
A lifetime interest rate cap that protects you by limiting how high your interest rate can go
(During the initial interest rate period, Option 1 represents a full principal and interest payment; therefore, Options 2 and 3 are not applicable.)
Option 1: Minimum Payment Due
This option gives you more cash now and keeps your monthly payments manageable
Payment changes annually and is calculated using the initial interest rate for the first 12 months
The minimum monthly payment is usually recalculated annually thereafter; and is based on the outstanding principal balance, remaining loan term and prevailing interest rate
7.5% Payment Change Cap limits how much this option payment can increase or decrease each year
(During the initial interest rate period, Option 1 represents a full principal and interest payment; therefore, Options 2 and 3 are not applicable.)
Interest Only Payment
At those times when the minimum monthly payment is not sufficient to pay the monthly interest due, you can avoid deferred interest by paying the minimum monthly payment plus any additional interest accrued during the month.
Payments remain manageable, with no change in your principal balance for that month
(Option 2 will not be offered if the interest only payment is less than the minimum payment due.)
Option 3: 30-Year Full Principal and Interest Payment
This is the fully amortized payment based on a 30-year loan.
Calculated each month based on the prior month's interest rate, loan balance and remaining loan term
Pays all of the interest due and reduces your principal, to pay off your loan on schedule (Option 3 will not be offered if the full principal and interest payment is less than the minimum payment due.)
Option 4: 15-Year Full Principal and Interest Payment
For faster equity build-up, quicker payoff and substantial interest savings, choose the largest monthly payment option.
Calculated to amortize your loan based on a 15-year term from the first payment due date
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