An option ARM gives borrowers the flexibility to select different mortgage payment options, including:
Principal and interest
Interest-only loans provide borrowers with the option to reduce their monthly mortgage payments by only paying the interest that is owed on the loan. The remaining loan amount stays the same during an interest-only period, as the borrower is not paying down the principal.
Interest-only programs are attractive to borrowers who have a limited cash flow or who wish to save money for other expenses, such as starting a business, repairing a home, or paying off a debt.
With the minimum payment option, the difference between the minimum payment and the full principal and interest payment gets added to the principal loan balance. When interest rates rise and the loan balance grows, many borrowers are sent into “payment shock”. At this point, they must either pay the loan, refinance, or go into foreclosure.
Option ARMs were never intended for homeowners. Instead, they were created for real estate investors who bought properties for “flipping”. An option ARM allowed an investor to minimize his or her monthly mortgage payments during construction, and then sell a property before rates increased.