Let me explain The Option Adjustable Rate Mortgage (ARM) in clear language:
For the past four to five years, the darling of residential lending has been the Option ARM.
The "Option" was the opportunity to choose how much payment to make each month. There are 4 options:

A. The borrower could make a payment that that amortized the loan over the standard 30 years.
B. The borrower could also make a larger payment and pay the principal down faster than required.
C. The third option was to pay only the interest that accrued each month and not payoff any principal.
D. The fourth option that got everyone’s attention was to make a less-than-interest-only payment.

Using Option D, a borrower could afford a monthly payment on larger mortgage than with a conventional amortizing loan. The tradeoff was that they borrowed a little bit each month against the equity in their home. The Option ARM has its place in today’s marketplace and a savvy investor can use it to their benefit.

The difference in dollars between what was paid on the minimum payment under option D. and the interest that actually accrued was called "negative amortization" or, the kinder, gentler, "deferred interest." Each month the deferred interest owed is added to the original loan amount. The next month the borrower pays interest on the deferred interest as well as the original principal balance. (Talk about digging a hole!)

Mortgage Brokers would advertise a "payment" based on ridiculously low rates like 1% or 1.375%. However, the small print in the mortgage note would clearly indicate that the actual rate the loan accrued interest at was a monthly INDEX plus a margin. The actual interest rate was 5% to 6% higher than the teaser "payment" rate.

The Standard Option ARM has a fatal flaw that seriously hurts the borrower. The actual interest rate changes every month even while the optional payment stays the same for 12 months. In a rising interest rate market, the loan can pile up deferred interest very fast. After one year, the minimum payment rises to keep the deferred payment gap a little smaller.

In fact, the optional less-than-interest-only payment rises every year until year 5. Then the new larger deferred principal balance is re-amortized over remaining 25 years at the then prevailing rate. At this point, the borrower can be faced with the crisis of a much larger payment at a higher rate owed on more money than they started.

Their options would be to refinance the loan, sell the property, or tighten their belt and make the payment. This may present an unpleasant problem for them. As a professional, a friend, and a generally caring person, I would not want to set up my clients for a problem like this.

The other factor that is hidden in the standard Option ARM is the actual interest rate is HIGHER than other prevailing rates. We have an interest rate market that favors long term rates but the OPTION ARM is based on the very short one month rate. Currently, short term rates are higher than long term rates.

The Option ARM also obscures the most important factor to the actual loan rate, and that is the Margin. The Margin is the fixed portion of formula; INDEX + MARGIN = ACTUAL RATE. The Index may change each month, but he margin stays the same. Many margins are 2.75% to 3.25% over the Index. The current Index is about 4.35%.

You can do the math.

Later today, I make a post about The Fixed Option ARM.

If you have any questions or if I can clarify any points within this post, please do not hesitate to comment.

Please visit my website for Naples real estate.

The LA Times newspaper had an interesting article on December 1st about the real estate market making a possible positive turn.

The author Annette Haddad pointed out that several noteworthy items leading to her conclusions:

1)  Forward looking economic indicators suggest the real estate market is stabilizing.

2)  On November 30th, based upon a client letter from Fred Alger & Co., an investment firm stating "While this real estate cycle has yet to play itself out, we are skeptical of the dire warnings of pundits"

3) Banc of America Securities, analyst Daniel Oppenheimer, stated "We believe that the improving affordability — due primarily to the decline in mortgage rates, but also the modestly lower home prices — is leading to the slight improvement in traffic," he said in a report explaining why he was shifting his yearlong stance on builder stocks from "cautious" to "neutral."  Further, slowing price gains are among the factors as "incremental positives" that are easing his worries about the real estate market.

4) Federal Reserve Chairman Ben S. Bernanke and his predecessor, Alan Greenspan — have joined a small group, but growing group in saying the sector might have bottomed out.

5) Recent interest rates on mortgage loans have been dropping.

Keep abreast of the Naples, Bonita Springs and Estero real estate markets by bookmarking this blog and reading future updates.

Read a previous post:  Time to Buy.

Share your thoughts and comments.

If your Naples single family home or condo is currently on the market here is a tip that could help to sell your property.  Consider offering prospective buyers a concession of paying a few percentage points on their loan.  This lowers the monthly payment for their mortgage loan, lower monthly payments means a greater number of buyers can qualify to purchase your property.

For more information about buying or selling Naples FL real estate, please visit my web site adeltarealty.net.

In many articles and government reports, we read about how poor the real estate market is today.  An important item to keep in mind – 1)  the statistics are global in nature 2) not all real estate markets are equal, nor are neighborhoods or subdivisions within a market area.  You may see this within your own town or city.

There are communities or subdivisions within the Naples, Bonita Springs and Estero areas, where you will not find an over-abundance of homes or condominiums on the market or the average days on market (ADOM) favorably compare to the area’s ADOM.  These areas represent a good value today.  Why?  People like living or having a second home in the community and have no desire to sell, because of this.  This preserves the value of the neighborhood, even during a down turn in the market.

We can look at Honda for a good example for preservation of resale value.  Have you ever seen a rental car company that offers Honda models for rent?  In all likelihood, you don’t.  Honda does not flood the market with fleet sales, thereby reducing the available number of cars for resale.

Another thought worth reflecting on, but still thinking about statistics.  There are areas that were "hot" during the past two years – but it do not have the test of time.  The areas were "fads" – kind of like "pet rocks" from a number of years ago.  Buying a property in one of these areas has always been an unwise decision.

One final point about real estate statistics is measuring the population growth or reduction.  As an area population grows there is a demand for housing.  Basic economics shows us that when there is demand the price usually will remain stable or increase.