Pay Option Arm vs. "Normal" Arm vs. Fixed

[Burke]

All,

I just wanted to see if anyone had any thoughts, recommendations or general words of wisdom (caution?) about a pay option ARM vs. a regular ARM vs. a fixed rate loan. My current investment strategy is to focus on SFH rental property (buy & hold) but I haven't purchased one yet. I am pre-approved and am in the search mode for a candidate property. The mortgage broker that I am working with is quick to share the benefits of a pay option ARM (what he calls a cash flow loan). Since I am looking at a buy and hold strategy, I am a little hesitant to use a loan that adds the unpaid interest to the balance of the principle but the broker is comparing the amount of unpaid interest that gets added against the anticipated increase in "cash flow" and believes the pay option ARM is still the way to go. He says that the increased cash flow resulting from the much lower payments of the pay option arm will far outweigh the unpaid interest. What I can't readily see in his calculations is whether or not the compouding of that added interest has been taken into account.

Would love to hear your thoughts on this and if anyone has some sort of tool that will allow a comparison of these products, that would be great as well.

Thanks in advance for your responses!

Burke

[David Leach]

All,

I just wanted to see if anyone had any thoughts, recommendations or general words of wisdom (caution?) about a pay option ARM vs. a regular ARM vs. a fixed rate loan. My current investment strategy is to focus on SFH rental property (buy & hold) but I haven't purchased one yet. I am pre-approved and am in the search mode for a candidate property. The mortgage broker that I am working with is quick to share the benefits of a pay option ARM (what he calls a cash flow loan). Since I am looking at a buy and hold strategy, I am a little hesitant to use a loan that adds the unpaid interest to the balance of the principle but the broker is comparing the amount of unpaid interest that gets added against the anticipated increase in "cash flow" and believes the pay option ARM is still the way to go. He says that the increased cash flow resulting from the much lower payments of the pay option arm will far outweigh the unpaid interest. What I can't readily see in his calculations is whether or not the compouding of that added interest has been taken into account.

Would love to hear your thoughts on this and if anyone has some sort of tool that will allow a comparison of these products, that would be great as well.

Thanks in advance for your responses!

Burke

Hi Burke,

I am a mortgage broker in Colorado and I recommend this program often. Alot depends on how long you plan to hold your properties on whether this program is for you. This is important to know going in because the loan will be reamortized after 5 years to make sure it is paid off in the remaining 25 years. This can create a big increase in your payments. Of course, you could always refinance at that point.

The negative amortization is easily offset by the appreciation in most cases. Even in a flat or slow market, the appreciation should cover it. You have to look at this type of loan as a program where you are able to borrow future equity in a property.

Another thing to remember is that you have the option to make a payment that would not result in negative amortization. This monthly rate is usually much lower than regular ARMs.

I hope this helps.

David

[mike_mn]

I dont like the option arm. You are faking cash flow.

IF the start rate is 1%, your payment is based on 1% for a year, but your rate jumps to 4-5-6% during the year. Because the payment increase is capped I believe, your payment still doesnt go up after the first year a whole lot, but your rate is still up there.

If you want to hold, why not just do an interest only loan at 6-7%. You can get a fixed 30 yr rate with 10 yrs of interest payments from First Magnus. The higher the rate the lower the closing costs should be.(low or no closing costs means more equity for you!) If you are not cash flowing interest only at 6%, then you shouldnt be renting or buying the property. If you are really getting that great of a deal, you should just resell it for profit.

Option arm only works to my eyes with heavy 10+% appreciation every year you have the loan. Or if you need a serious tax write off every year to offset your income.

My 2c