To make the decision that is best for you, you will need to understand the features and benefits of each pmt. option. The following is an illustration of your monthly loan statement and a brief description of the options:

• Option 1 - Offers the lowest payments - (Minimum pmt.):

The Minimum payment is usually calculated using the *1st month "Starting Rate." The Starting Rate is a Principal and Interest (P.I.) Rate for the first month of the loan program.  You will find the "Starting Rate" on the Rate Sheet.  The purpose of the "Starting Rate" is to create or establish the "Minimum payment" (or the lowest payment you are allowed to make for the next twelve (12) months and for several years following.)  Beginning in month two, the "Minimum" pmt. is no longer a Principal and Interest payment; it's just the minimum the Lender requires you to pay.  Beginning in month two, there will be little or no Interest reduction (more or less Interest reduction depends upon the then fully-indexed Rate {Index + Margin} in relationship to your "Starting Rate." I.e., if the Starting Rate is higher and the current Fully-Indexed Rate is lower, you would defer less Interest.)  There have been years where the Index was decreasing when the "Minimum pmt" actually moved higher than the "Fully-Indexed" pmt. or Scheduled pmt. In that event, the Lender would begin to lower the "Minimum pmt. every year via the yearly 7.5% payment cap, until it finally equaled the Fully-Indexed/Scheduled pmt.

Of course if you are making only the "minimum" pmt. you will have periods of deferred interest (loan balance will be increasing) therefore you must also keep these variables to keep in mind:

• Your market value could also be increasing

• your savings portfolio should be increasing

• your credit card debt should be decreasing  

Beginning in month two, your outstanding loan balance is multiplied by the Fully-indexed Rate (Index + Margin.)  Beginning in year two, the 7.5% Yearly Payment Cap will be applied to your outstanding principal balance. In time, the "Minimum payment" will become a full Principal and Interest payment called the "Scheduled payment."

So how does the Principal Balance change? Let's begin by explaining the term "Principal Balance." The Principal Balance is your beginning Principal & Interest balance (i.e. day one) and at every five (5) year period. Since you can never defer Principal but only Interest, your Principal balance can never increase.  Therefore, if you are only making the "Minimum" pmt. there could be times when this payment may not be sufficient to pay the full amount of interest due and deferred interest/negative amortization may accrue.  The Lender adds this accrued but unpaid interest to the unpaid principal balance of the loan.  Until repaid, deferred interest bears interest at the fully-indexed Rate of the loan. If you have deferred interest, it will always be shown (in a box) on your monthly statement.  You will always be allowed to pay off any deferred interest by adding an extra amount at anytime.  All deferred Interest must be paid off prior to any Principal reduction. With this said, the Principal Balance may never exceed *110% of the original Principal Balance amount (some lenders allow for a max 115% or 125%.) If deferred interest caused the Principal Balance to reach these limits, the Lender would immediately increase the "Minimum" payment without regard to the 7.5% payment. Again the Lender has the right in the 5th, 10th, 5th, 20th, and 25th years, to take the amount of deferred interest (if any), and add it to the existing balance and "recast" or re-amortize the loan so that it will still pay off on its original term, e.g. 25 yr. amortization.  Some Lenders may have a 10 year recast provision instead of a 5 year; however, the Lender may still recast your loan at any time if you reach the maximum Principal Balance limit listed above.

 * Your recast provision, i.e., 110%, 115% or 125% will be displayed on your Truth-In-Lending Statement.
 

• Option 2 - Pays all the interest - (Interest-only pmt.):

You are allowed to pay all the Interest due with no change in your principal balance. However, the Lender will eventually apply the yearly 7.5% payment cap and increase your next years %-Only pmt. to include some Principal reduction in order to keep your 30 or 40 yr. term on its proper payoff (just like the Minimum pmt. option.)

• Option 3 - Pays all principal & interest - (Scheduled pmt.):

This is the fully amortized or P.I. payment (Index + Margin) also called the full "Principal and Interest" pmt. and the Scheduled pmt. This pmt option is achieved by adding the Margin to the current monthly Option ARM index X the outstanding loan balance.  If you always pay the fully-Indexed Rate, you will never have deferred interest and the 7.5% yearly payment increase will not come into play.  You are allowed to make this pmt. every month beginning with month *two.  If you make this payment, your loan balance would always decline regardless of the movement of the Index. This is because your loan balance should be lower each month (even if the Index were increasing) as the Lender would re-adjust your next "Scheduled payment" higher to compensate for the higher Index. Moreover, your future Scheduled pmts. could actually decrease even if the Index were increasing.

Here is an example:

$250,000 mortgage balance on 01/01/04, an Index of 1.229% and a Margin of 2.75% for a fully-indexed Rate of 3.979% (2.75% + 1.229%.)  This would create a "Scheduled payment" of $1,190.51.  Let's assume on 02/01/04 the Index increased by 0.05 bps. to 1.234% for a fully-indexed Rate of 3.984% (2.75% + 1.234%.)  Because the new loan balance would be lower, i.e., $249,638, the new monthly payment would actually drop by $1.72 or ($249,638 x 3.984% = $1,188.79.)  (There have been times {when the Index was decreasing over a long period of time} when the Lender had to lower the "Scheduled pmt." because too much rapid amortization was occurring. In that event, the Lender would begin to lower the "Scheduled pmt" on a yearly basis via the yearly 7.5% payment cap until it was back on its normal amortization period, i.e., 30 or 40 years.) 

• Option 4 - 15 yr. pmt.:

For faster equity build-up, quicker payoff and substantial interest savings choose the this monthly payment option. Option 4 is calculated to amortize your loan based on a 15-year term for the first payment due date.
 

• Option 5 - Pay any amount over the Minimum pmt.:

For even faster equity build-up, a quicker payoff, or to lower your future monthly payments, you will always be allowed to pay any amount over the "Minimum" payment. Just add an extra payment anytime you like, but not more than the allowable pre-payment period {if applicable.} Since you will always have a new loan balance every month, you can add a larger payment, thus lowering your next month's loan balance giving you a smaller "Scheduled pmt." However, keep in mind that all Option ARMs must still pay off on its respective time frame or amortization, i.e., 30 or 40 yrs.  With this said, there are 3 main variables to predicting your future lower pmt. if you are planning on pre-paying with an extra lump sum:

 2. Deferred Interest? - All deferred interest must be 1st be paid off. E.g., assuming you have been making the "Minimum" pmt. for the past 5 yrs,  if going into yr. 6, mo. 1, you have a PI bal of $300k in addition to $8k of deferred interest and you pre-paid an extra $20k that mo, only an est. $12k will go to your PI bal. reduction.

Let's assume that going into month 2 of yr. 6 your Index increased, and it kept increasing for the next 10 months, you would begin to see a new "Minimum" and Interest-only" pmt. option.  However, if your Index was dropping at that time and it kept dropping every mo. for the next 10 mos., your Scheduled pmt. could actually be lower than the Minimum or Interest due at that time. Thus the computer would actually lower your next years (yr. 7) Scheduled pmt. via the yearly 7.5% payment. in order to reduce your assumed "rapid amortization." I.e., if you were paying the Scheduled pmt. and the Index dropped for 11 months in a row, you would be making pmts. higher than your normal 25 yr. amortization.  Therefore, if your Index kept dropping or raising over a long period of time, in order to keep you on your correct amortization payoff, the computer will always re-adjust your next years Scheduled pmt. either higher or lower.        
 

(All of the above monthly pmt. options will be displayed on your monthly statement except for option 5, as this is left blank so you can write in any amount that you like. You just need to put a check mark next to what option you would like to pay that month. If you are set up with "auto pay" (recommended) you can either mail a check or transfer in extra funds.)

Some Further Explanation

From time to time, depending on the fully-indexed Rate and the payback schedule you select, some options may be less than the "Minimum amount due" or not available. In this case, those options will be indicated as "not applicable" on your monthly statement.

The circumstances under which payment options may not be offered are as follows:

During the initial rate period, the Minimum payment option represents a full principal and interest payment; therefore, Options 1 and 2 are not applicable.

Option 1 will not be offered if the interest only payment is less than the Minimum payment due.

Option 2 will not be offered if the full principal and interest payment is less than or equal to the Minimum payment due.

No options will be offered if the loan is delinquent; then the total amount due will be required.

In Summary:

• The Index changes every month, but the Margin never changes. 
   

• You can never increase your Principal balance as you can only add "deferred Interest" to you loan balance which must eventually be paid off.
   

• The Option ARM balance changes monthly regardless of what payment option you choose.
   

• The Minimum pmt. is one of five (5) monthly payment choices or options.
   

• No matter which pmt. option you choose, your loan still must be paid-off in 30 years or less (some programs allow for a 40 yr. term.) 
   

• If you paid just the "Minimum" pmt. and you deferred any Interest, it will always be reflected in a box on your monthly statement. You will always have the option of paying this deferred interest off in full, or the Lender will just increase your next years "Minimum" pmt. by 7.5% Payment Cap. 
   

• You will have a new loan basis every month, e.g., every month when a new pmt. is made, it will either lower or raise your outstanding loan balance. This is one of the only loans that allows for a future lower pmt. reduction. 
   

  • The Margin is fixed
     

  • The Index changes ever month either higher or lower
     
  • Fixed lifetime interest rate cap 

   

More on the "Minimum" pmt:

You might want to think of the "Minimum payment" as you would the minimum payment on a credit card; e.g., you can have a large balance, or a small balance, but every month your credit card Lender will give you a choice of how you can pay it.  You can pay all the principal and interest (P.I.) due that month, pay the balance off completely, or just pay the minimum amount due.   Another way to think of the Minimum payment option is to realize it works like a 2nd mtg. (or HELOC) but with no extra fees or higher interest rates.  People often say that they are afraid of the Option ARM's Minimum pmt. because it will make their mtg. balance go higher; but when asked if they've ever thought about getting a 2nd mtg. they will say yes.  And when they realize that a 2nd mtg. will also increase their loan balance (usually at a much higher Interest Rate) their concerns are greatly reduced. 

AAMI recommends if you plan on just making the "Minimum payments" you should use this extra cash-flow (or difference between making the full P.I. pmt./Scheduled pmt.) to first get yourself out of debt, mainly credit cards.  If you have no existing debt, it might make sense to invest this extra cash-flow into an ultra safe savings portfolio.  Please remember this extra cash-flow is actually your equity, but in a different form.  E.g., instead of developing equity (or the difference between what you owe vs. how much your house is worth) by driving down your loan balance in the early years of your term by making larger monthly pmts., if you instead saved the extra cash-flow by placing it into your savings portfolio, if you invested wisely, you might be able to actually pay your Option ARM mortgage off faster by making one large payment into your future loan balance.  With this said, AAMI is not a Financial Planner, Accountant nor Attorney, therefore this extra cash-flow option may not be appropriate for everyone.
 

* Some Option ARM programs have a 3-month "Starting Rate" which is a fixed PI payment. However, other Option ARM programs like the COSI and CODI offer a Starting Rate but the outstanding loan bal is calculated at the fully-indexed Rate beginning on day one.

• Underwriting guidelines for a "reduced doc" (stated-income) & NINA or No Income, No Assets are proved but just stated on the Application
   
• Underwriting guidelines for a Full Doc. Pay Option ARM
   
• Explanation of all Option ARM Index's
   
• Option ARM Rate Sheet