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HYBRID OPTION ARMS
Click here for the Hybrid Option ARM Calculator
There is a new Option ARM loan product in the marketplace… and its popularity has been increasing rapidly. It's the "Hybrid" Option ARM (also known as a Fixed Option ARM). The Hybrid Option ARM is a cross between a 5-year Fixed Interest Only, and a Pay Option ARM. In its simplest form, it is a 5-year Interest Only ARM with an added feature of a 3% lower interest rate payment option. The start rate and the fully indexed rate are "fixed" for the majority of the 5 years. This loan, like the traditional Option ARM, has a recast feature built into it, in the event that the loan balance grows to 115% of its original balance. When that happens, the low start rate payment goes away. This is less likely to happen on the Hybrid Option ARM because the start rate is higher than on the traditional Option ARM, and therefore doesn't neg am as quickly.
This loan appeals especially to the borrower that has had an interest in the "traditional" Option ARM product, but was fearful of the fully indexed rate (true interest rate) escalating to its max cap rate of 9.95%. The traditional Option ARM typically begins with a very low start rate, usually around 1% or 1.25%, and has a fixed margin and an index that is "variable," thus making the fully indexed rate adjust monthly. This would in turn cause the loan balance to grow in greater amounts. To slow down the neg am process, the start rate payment on the traditional Option ARM will increase annually by 7.5% of the payment amount. Some borrowers have confused that with thinking that their interest rate was going up by 7.5%, which is indeed not the case. On the Hybrid Option ARM, the start rate payment amount is fixed for 5 years, or until the loan recasts.
There is really no downside to this loan product and it makes a lot of sense when you truly understand all of its features. It is not for the borrower whose financial goal is to pay off their home as quickly as possible. But for the borrower who is looking to put the equity in their home to work for them and earn a rate of return, it is a valuable financial tool.
* neg am = negative amortization
DIFFERENCES BETWEEN TRADITIONAL OPTION ARM
AND HYBRID OPTION ARM
Traditional Option ARM
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Hybrid Option ARM
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- Low start rate; usually 1%-1.25%. Payment amount adjusts upward by 7.5% each year.
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- Start rate is fixed for 5 years (usually begins at 3-4% below the fully indexed rate).
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- Fully indexed rate adjusts monthly.
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- Fully indexed rate is fixed for 5 years.
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- Gap between the start rate and fully indexed rate is wider, thus making the loan balance neg am more rapidly.
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- Gap between the start rate and fully indexed rate is smaller; thus the loan balance doesn't grow by as much.
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Example Scenario:
The following example shows the benefits of the Hybrid Option ARM loan on a typical home purchase or refinance.
- Home Value: $500,000
- Loan Amount: $400,000 (Assuming 20% Down on a purchase or 20% Equity on a refinance.)
- Product: 5-year Hybrid Option ARM
- Payment: $1291.67/month at the 3.875% initial "payment rate"
(The full Interest-Only Payment would be $2291.67/month at the full "accrual rate" of 6.875%)
- Savings: $1000.00, which will be added to the Principal amount each month.
Does the Hybrid Option ARM make good financial sense?
You be the judge!
Here is how this one works:
Assuming 6% Market Appreciation...
- YEAR 1: Your loan balance would grow to $412,000, but your home value would grow to $530,000 ($118,000 equity in home). You would have $12,000 additional cash for investment purposes.
- YEAR 2: Your loan balance would grow to $424,000, but your home value would grow to $561,800 ($137,800 equity in home). You would have $24,000 additional cash for investment purposes.
- YEAR 3: Your loan balance would grow to $436,000, but your home value would grow to $595,508 ($159,508 equity in home). You would have $36,000 additional cash for investment purposes.
- YEAR 4: Your loan balance would grow to $448,000, but your home value would grow to $631,238 ($183,238 equity in home). You would have $48,000 additional cash for investment purposes.
- YEAR 5: Your loan balance would grow to $460,000, but your home value would grow to $669,112 ($209,112 equity in home). You would have $60,000 additional cash for investment purposes.
Put the savings to work for you:
If you take the $1000/month payment difference between the 3.875% "payment rate" and the 6.875% "accrual rate," and invest it at 7% annually, here is how that would look:
- YEAR1: You'll have $12,465 at the end of the year.
- YEAR 2: You'll have $25,831 at the end of the year.
- YEAR 3: You'll have $40,163 at the end of the year.
- YEAR 4: You'll have $55,531 at the end of the year.
- YEAR 5: You'll have $72,011 at the end of the year.
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