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Many lenders and brokers now-a-days often advertise loan programs at 1% interest rate (some at 1.25%, or 1.95%). These programs are also referred as Pay Option ARM, Flexible Payment Program, Power Option Program, or One Month Option ARM program. This is how it works. The lender offers the borrower 1% interest rate for the first month (also referred as teaser rate), and the borrower will continue to make the payment at 1% principal and interest amortized for 30 years for the remaining year, however, the borrower, after the first month, will be charged at Note Rate (Index plus Margin). The Note Rate is calculated and adjusted month by month (because Index changes) even though the payment amount remains constant for the whole year. The difference between the interest you actually paid (at 1%) and the interest you were actually owed is called Deferred Interest. Sometimes, but not always, you pay less in the interest than you owe, then the difference is added to your principal, thus resulting in increases in principal. Therefore some people also called this type of programs negative amortization programs. Each month you will have option either pay minimum at 1% (Principal and Interest), interest only, 15 year (using Note Rate amortized for 15 years), or 30 year (using Note Rate amortized for 30 years). Starting the second year, the payment will be increased by 7.5%. The payment for the following year will again be increased by the same percentage and so on, until the payment matches the amount to repay the loan back for the remain of the 30 year term or the increased principal reaches 110% of the original principal amount. To minimize the fluctuation of the variable Index, many lenders offer more stable Indices such as 12 month average of monthly treasury bills or less volatile average saving rates. The downside of this type of programs is that it can result in increase in principal (negative amortization), and the fact that the interest rate is adjusted monthly. Also the payment may increase if the interest rate increases suddenly. The upside is the program reduces the monthly payment for the first few years, makes the homeownership more affordable and yields more dispensable cash flow. The following is a payment example for a $400,000 loan at 1% starting rate compare to 30 year at 4.287% fully indexed Note Rate. Payment Options
Still like to find out more? You can use the following calculator to figure out your own payments. Click here to start 12 MAT Calculator
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