It’s mind-boggling how many loans are out there. Just when you think you’ve grasped how an ARM works you learn that there are multiple types of ARM loans. The 3 most common Adjustable Rate Mortgage (ARM) types today are Hybrid ARMs, Option ARMs, and Hybrid Option ARMs. While they all have a similar ring, they function distinctly.
Hybrid ARMs
Hybrid ARMs is what you get when you combine a traditional fixed rate mortgage and a classic ARM. They come in varieties indicating how long they are fixed and how often they adjust thereafter. A 4/1 ARM will have a fixed rate for the first four years, and can then adjust once every year after. A 3/1 would be fixed for three years and is then adjusted every year thereafter, and 5/1 fixed for five years, and so forth.
An adjustable rate mortgages can only be adjusted with the use of an index such as the MTA, COFL, or LIBOR. These rates indicate a basic borrowing cost of capital for the lender. They also have a margin, which is like a risk premium, their profit for making the loan.
Hybrid ARMs are characterized by the following:
- Start Rate remains fixed for a specified amount of time. As explained previously, this means that a 6/1 lasts six years and adjusts once a year every year after the six-year mark.
- Adjustment Cap Structure dictates how much the rate can change after the loan begins adjusting. A 5/1/5 adj. cap structure means that the first time the rate adjusts it can go up or down 5 points max, any subsequent adjustments are limited to one point up or down, and the rate can never go up or down more than five points. Such a cap, ensures that the homebuyer is not ambushed by an unfavorable interest rate.
- Ceiling is a rate which the note rate or fully indexed rate can never go higher than 9.95-11.95 depending on lender and index.
The minimum payment on a 100,000 dollar regular Hybrid ARM with a 7% rate would be a bit over 665 dollars. What’s so appealing about this loan is that borrowers of all credit levels qualify for Hybrid ARM mortgages.
One Month Option ARM
Option ARMs are one of the most popular loan types in today’s housing market. Option ARMs are similar to regular ARMs, but have four payment options instead of just the one fully amortized payment option on a regular mortgage. The minimum payment option is the most appealing aspect for the majority of the Option ARM customers in the USA. The minimum payment for the initial period of the loan for 100,000 dollars would be 322 dollars, versus 665 dollars for the full payment on a conventional mortgage.
One month option ARMs adjust every month after the initial period. If the initial period is six months or one year, then every month after the rate adjusts. There are six month and one year option arms wherein the payment adjusts every six months or once a year thereafter as well. One month options ARMs They have additional features in addition to standard Hybrid ARMs:
- A Minimum Payment. A payment plan akin to a credit card that allows you to stay current on the mortgage without paying the full amount of interest due, referred to as deferring interest.
- A Minimum Payment Adjustment Cap. The maximum amount that the minimum payment amount can increase or decrease in a given period. Typically 7.5%. So if your minimum payment is 1000 dollars, then in the next period it can not go higher than 1075 dollars.
- A Negative Amortization Cap. This is the maximum the loan balance is allowed to increase due to deferral of interest (making the minimum payment only) before the loan is re-cast and the minimum payment option goes away. Depending on state and LTV this is 110% to 120% of the loan amount.
Option ARM e.g.
On a $100,000 Option ARM with a 1% start rate, a base or index rate of 4% and a margin of 4%,
– Minimum Payment = 322
– Interest Only = 667
– Deferred Int. = 345 (IO minus Min Pay)
– 1 Year Neg. Am. = 4140
– Recast Balance = 115000 (assuming 115% neg-am cap)
– Months to Recast= 43 (assuming you only make the minimum payment)
When a regular option arm exceeds its negative amortization cap and recasts (typically in three and half to four years if you’re only making the minimum payment) the minimum payment option is negated thus leaving you with the fully amortizing payment. Because of the supple nature of these loans, only credit borrowers with solid credit scores of 660+ need apply.
Hybrid Option ARMs or Fixed Rate Option ARMs
Hybrid Option ARMs combine some the best features of Hybrid ARMs, such as medium term fixed rates, with the best aspects of Option ARMs, such as low minimum payments, while solving a lot of the problems with both for the average borrower. They are most popular with homeowners who want the stability of a fixed rate mortgage but the option to make low minimum payments and are considered an ideal compromise between “safety” and “flexibility” in the mortgage world.
Hybrid Option ARMs are generally based on normal Hybrid ARMs, in that their initial period is usually 3/1, 5/1, 7/1 or 10/1 meaning 3, 5, 7 or 10 years where the rate and minimum payment stays fixed, and 1 adjustment per year afterwards.
However they have Option ARM like features such as a minimum payment, minimum payment adjustment cap, and neg am cap.
Using the above example the same loan amount in a typical hybrid option arm package
– Minimum Payment = 449 (assuming 3.5%)
– Interest Only = 583
– Deferred Int. = 134 (1/3 of regular option arm)
– 1 Year Neg. Am. = 1608
– Recast Balance = 115000 (assuming 115% neg-am cap)
– Months to Recast= 112 (assuming you only make the minimum payment)
Also, when hybrid option arms recast, most of them allow for an Interest Only option instead of forcing the borrower into a fully amortized payment they might not be able to afford. Along with the long recast timeframes and the fixed rates for the initial period, this substantially reduces payment shock on recast.Keep exploring Hybrid ARMS, Option ARMs, and Hybrid Option ARMs, to find out which one works for you. This article serves as a primer. To gain a more intimate understanding of the aforementioned mortgages, consult with Wyoming mortgage lenders near you. At Affiliated Mortgage you’ll have all your home financing concerns dealt with in a respectful and informative manner.
It’s mind-boggling how many loans are out there. Just when you think you’ve grasped how an ARM works you learn that there are multiple types of ARM loans. The 3 most common Adjustable Rate Mortgage (ARM) types today are Hybrid ARMs, Option ARMs, and Hybrid Option ARMs. While they all have a similar ring, they function distinctly.
Hybrid ARMs
Hybrid ARMs is what you get when you combine a traditional fixed rate mortgage and a classic ARM. They come in varieties indicating how long they are fixed and how often they adjust thereafter. A 4/1 ARM will have a fixed rate for the first four years, and can then adjust once every year after. A 3/1 would be fixed for three years and is then adjusted every year thereafter, and 5/1 fixed for five years, and so forth.
An adjustable rate mortgages can only be adjusted with the use of an index such as the MTA, COFL, or LIBOR. These rates indicate a basic borrowing cost of capital for the lender. They also have a margin, which is like a risk premium, their profit for making the loan.
Hybrid ARMs are characterized by the following:
- Start Rate remains fixed for a specified amount of time. As explained previously, this means that a 6/1 lasts six years and adjusts once a year every year after the six-year mark.
- Adjustment Cap Structure dictates how much the rate can change after the loan begins adjusting. A 5/1/5 adj. cap structure means that the first time the rate adjusts it can go up or down 5 points max, any subsequent adjustments are limited to one point up or down, and the rate can never go up or down more than five points. Such a cap, ensures that the homebuyer is not ambushed by an unfavorable interest rate.
- Ceiling is a rate which the note rate or fully indexed rate can never go higher than 9.95-11.95 depending on lender and index.
The minimum payment on a 100,000 dollar regular Hybrid ARM with a 7% rate would be a bit over 665 dollars. What’s so appealing about this loan is that borrowers of all credit levels qualify for Hybrid ARM mortgages.
One Month Option ARM
Option ARMs are one of the most popular loan types in today’s housing market. Option ARMs are similar to regular ARMs, but have four payment options instead of just the one fully amortized payment option on a regular mortgage. The minimum payment option is the most appealing aspect for the majority of the Option ARM customers in the USA. The minimum payment for the initial period of the loan for 100,000 dollars would be 322 dollars, versus 665 dollars for the full payment on a conventional mortgage.
One month option ARMs adjust every month after the initial period. If the initial period is six months or one year, then every month after the rate adjusts. There are six month and one year option arms wherein the payment adjusts every six months or once a year thereafter as well. One month options ARMs They have additional features in addition to standard Hybrid ARMs:
- A Minimum Payment. A payment plan akin to a credit card that allows you to stay current on the mortgage without paying the full amount of interest due, referred to as deferring interest.
- A Minimum Payment Adjustment Cap. The maximum amount that the minimum payment amount can increase or decrease in a given period. Typically 7.5%. So if your minimum payment is 1000 dollars, then in the next period it can not go higher than 1075 dollars.
- A Negative Amortization Cap. This is the maximum the loan balance is allowed to increase due to deferral of interest (making the minimum payment only) before the loan is re-cast and the minimum payment option goes away. Depending on state and LTV this is 110% to 120% of the loan amount.
Option ARM e.g.
On a $100,000 Option ARM with a 1% start rate, a base or index rate of 4% and a margin of 4%,
– Minimum Payment = 322
– Interest Only = 667
– Deferred Int. = 345 (IO minus Min Pay)
– 1 Year Neg. Am. = 4140
– Recast Balance = 115000 (assuming 115% neg-am cap)
– Months to Recast= 43 (assuming you only make the minimum payment)
When a regular option arm exceeds its negative amortization cap and recasts (typically in three and half to four years if you’re only making the minimum payment) the minimum payment option is negated thus leaving you with the fully amortizing payment. Because of the supple nature of these loans, only credit borrowers with solid credit scores of 660+ need apply.
Hybrid Option ARMs or Fixed Rate Option ARMs
Hybrid Option ARMs combine some the best features of Hybrid ARMs, such as medium term fixed rates, with the best aspects of Option ARMs, such as low minimum payments, while solving a lot of the problems with both for the average borrower. They are most popular with homeowners who want the stability of a fixed rate mortgage but the option to make low minimum payments and are considered an ideal compromise between “safety” and “flexibility” in the mortgage world.
Hybrid Option ARMs are generally based on normal Hybrid ARMs, in that their initial period is usually 3/1, 5/1, 7/1 or 10/1 meaning 3, 5, 7 or 10 years where the rate and minimum payment stays fixed, and 1 adjustment per year afterwards.
However they have Option ARM like features such as a minimum payment, minimum payment adjustment cap, and neg am cap.
Using the above example the same loan amount in a typical hybrid option arm package
– Minimum Payment = 449 (assuming 3.5%)
– Interest Only = 583
– Deferred Int. = 134 (1/3 of regular option arm)
– 1 Year Neg. Am. = 1608
– Recast Balance = 115000 (assuming 115% neg-am cap)
– Months to Recast= 112 (assuming you only make the minimum payment)
Also, when hybrid option arms recast, most of them allow for an Interest Only option instead of forcing the borrower into a fully amortized payment they might not be able to afford. Along with the long recast timeframes and the fixed rates for the initial period, this substantially reduces payment shock on recast.Keep exploring Hybrid ARMS, Option ARMs, and Hybrid Option ARMs, to find out which one works for you. This article serves as a primer. To gain a more intimate understanding of the aforementioned mortgages, consult with Wyoming mortgage lenders near you. At Affiliated Mortgage you’ll have all your home financing concerns dealt with in a respectful and informative manner.
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