Across America there are a record number of loan defaults and foreclosures and some blame, in part, a loan program called the Option Arm. The truth of it is these can be great tools for mortgage professionals to use with the right clients or they can be complete nightmares for others.

Option Arm’s give borrower’s great flexibility in payments, which can be very useful for those borrowers that have fluctuating incomes. Those borrowers that work on commission, receive a large portion of income as bonuses or those that are starting new in their business where a substantial change in income will come down the road. On the other hand, for those borrowers that utilize an Option Arm loan to afford the home purchase is setting themselves up for disaster.

It is critical that you work with a knowledgeable Certified Mortgage Planner that knows the ins and outs and explains in great detail how the Option Arm works. In 2000 there were only two or at most three lenders that offered these types of loans. As their popularity grew among borrowers by 2003 nearly every single lender in the U.S. had some form of Option Arm product.

All Option Arms are not created equal. They each have differences and depending on the borrower these differences can be catastrophic. At the very least you should to have a basic understanding of adjustable loans and how they work. This means at a minimum, you should already know what margin and what index mean in the context of any arm loan before looking into this loan product.

Part of the mystification of Option Arms is the many “working parts” and how they integrate into the loan. It’s very important that the loan officer know each and every detail and can explain each part so the borrower can make the most informed decision. This will vary greatly lender to lender. At a very minimum some are:

• Margin
• Index
• Minimum Payment
• Fully Indexed Payment
• Deferred Interest
• Recast Point                            
• Payment Caps
• Interest Rate Caps
• Pre Payment Penalty

The biggest error a borrower can make when getting an Option Arm would be when the pre-payment penalty is longer than the recast point. This can be detrimental to the borrower and cost tens of thousands or worse put the wrong borrower in foreclosure.

The loan officer should be able to provide a detailed analysis of your yearly payments, when exactly the loan will recast and how much deferred interest you may accumulate. Get an amortization schedule. If they can not provide these items do not take out the loan or find a knowledgeable one that can.

The bottom line is this is a great tool in the right hands, provided by a knowledgeable loan officer, to build wealth for borrowers and used to achieve your financial goals.