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Option ARM as debt consolidation mortgage continued

Fri May 19, 2006 12:05PM | By Tony

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This Option ARM - debt consolidation loan piece is the conclusion of recent debt consolidation mortgage article. Option ARM comes in 2 flavors - with 1 or 3 month introductory period with start rate of about 1.375% and 2% respectively. So during this period, the teaser or start rate on your Option ARM debt consolidation loan is much lower than the Fully Indexed Rate which is calculated as the sum of index value and margin. This start rate is used to calculate the Minimum payment that you must pay for the first 12 months. This Minimum payment stays the same even when the start teaser rate is no longer in effect and your debt consolidation loan interest rate is computed at the Fully Indexed Rate. What it means that once your 1 or 3 months end, the interest on your loan is charged at the rate that by far higher as index value that is used to calculate the rate, increases these days quite robustly. Note that the minimum payment is the smallest amount you must pay monthly.

There are 2 most popular indexes used at Option ARMS - 12 month Monthly Treasury Average (MTA) and 11th District Cost of Funds Index (COFI). MTA index stands today at 4.143%, and COFI is at 3.624%. Add to this margin which when you apply for your debt consolidation loan, will be around 3.075% for MTA and 3.850% for COFI, and you have the fully indexed rate of 7.218% and 7.474% respectively. Of course you can only pay your minimum payment, but what will happen to the remaining unpaid interest? It will be added to you principal thus increasing your loan and decreasing your equity each month you choose or are forced by the lack of money to make minimum payment. That is called negative amortization and isn't a very good idea for a homeowner. Some debt consolidation loan you got. Sure you save yourself tons of cash but you can quickly deplete whatever little equity left after the cash out refinance you just did to get this Option ARM.

The minimum payment is your First option and stay the same for 12 months unless your unpaid principal balance increases to more than 125% of the original loan amount. In New York is 110%.

The Second option is interest-only payment. You pay full interest each month to avoid negative amortization. Again as the interest rate changes from month to month, so will be the amount of your payment.

The Third option is paying full principal and interest payment based on the 360 or 480 months - whichever you chose when you got this debt consolidation loan.

The Fourth option is paying full principal and interest based on 180 months, so you can pay more towards principal. During the introductory teaser period, the only 2 options are often option One and Four.

The bottom line is when you hear that the "payment options put you in control" or "you will cut your mortgage payment in half" or my favorite, "why continue to struggle, consolidate your debt, put your mortgage to work for you, be debt free, we will pay the last nickel in closing costs for you", watch out. Now as the disclaimer we must say that this is just to demonstrate the pitfalls of Option ARM. For a full guide about Option ARM, contact your lending institution, banker, broker, etc. Finally, Option ARM can be used in few ways to some benefit, but we will talk about later.