The Option Arm's In's and Out's (Who's it good for)

Mortgage and Lending with Model Citizens "NO POINT LOANS"

This is one of the hottest products on the market with the savvy investors:

The "Option ARM" is a product that gives you choices as to what payment you want to make.
This product goes by a number of different names:
Option ARM
PayOption ARM
Pick-a-Pay Loan
Cash-flow ARM
Millionaires Mortgage

Usually, there are four payment options. 1) 30 year fixed; 2) 15 year fixed; 3) Interest Only; 4) Minimum payment (negative amortization - also known as deferred interest).

The only one of those payments that is unique - is the negative amortization option. The minimum payment option concept is simple: Basically, you make a payment that is less than the amount of interest that you were charged for the month. So, maybe you started the month owing $1,000,000 - but at the end of the month you might owe $1,000,300. At the end of the next month if you did it again, you might owe $1,000,600.

So - who are these loans good for? Ideally, these loans are good for people who value cash flow. These people are willing to pay higher rates of interest to keep their payments low because they believe they can use that cash for better purposes. For the most part, these loans are best for people who are strong financially. These people have a lot of money in the bank and invest the cash flow into other things.

Who are these loans not so good for? These loans aren't good for people who are struggling to make a house payment. The problem with people taking this loan who aren't financially strong is that they are falling behind month after month. And, they often end up paying more interest than if they had taken a product that fixes in the interest rate for a period of time.

Right now, in the United States, there is an estimated $500 billion to $800 billion of these Option ARMs out there.

The rate generally changes every month. At the beginning of each month, the computer looks at two things to calculate the rate the margin and the index. However those with this product making the minimum payment hardly care about the rate adjusting. They are only concerned about the 2% rate fixed for 5 years.

The index is nothing more than some interest rate that has been chosen by the lender. Lenders use different indices. Some of the indices are:
LIBOR - London Inter Bank Offering Rate.
MTA - Monthly Treasury Average (this takes the 1 year Treasury rate for the last 12 months and divides by 12).
COFI - Cost of Funds Index (a bunch of west coast banks take an average of their short term rates)
COSI - Cost of Savings Index (west coast banks take an average of the rates they are paying on savings accounts)

All of these indices are measures of short term interest rates. One way or another, they are all being highly influenced by the Fed Funds rate that the Federal Reserve sets. As the Fed keeps taking the Fed Funds rate lower - all of these indices will go lower (which will mean the Option ARM client will pay less and less).
If you have any questions feel free to call me. 804-432-3708 or email me at

Comments (3)

Jen Hudson
Windermere Real Estate/M2, LLC - Stanwood, WA
Stanwood, Camano & Arlington, WA
You make a very good point.  Some of these loans aren't bad deals at all, they just need to be utilized by the right person. 
Jan 12, 2008 04:53 AM
Sean Allen
International Financing Solutions - Fort Myers, FL
International Financing Solutions

Good explanation on the option arm ..... which is a dieing breed of loan.

Sean Allen

Jan 12, 2008 04:54 AM
Esko Kiuru
Bethesda, MD


Option ARM can also be useful for those who are disciplined in their financial dealings and whose income fluctuates, like tip earners here in Las Vegas. Many borrowers of the recent past misunderstood how it works.

Jan 12, 2008 05:19 AM