Flexible Payment ARMs

Flexible Payment Adjustable Mortgage Rates (FPARMs) are ARMs that allow the rate to adjust monthly with no caps, and that allow borrowers to start with extremely low initial payments that rise over time. The major downside of FPARMs is that those who choose the very low initial payment option can suffer from payment shock, and often do not understand the complexities inherent with these loans.

The main thing that makes FPARMs attractive to many consumers is, of course, the very low initial payments. The early savings allows many to afford a larger loan, and can be used to pay off other debt, make home improvements, make investments, and a long list of other possible uses. However, you shouldn’t let the thought of low early payments and what you will do with the savings blind you to the risk of FPARMs.

The initial rate on an FPARM is a “teaser” and can be as little as one and a quarter percent. When looking at your baseline rate, though, be careful to find out what the margin is. The margin will affect the rate of every month but the first, so is very important. FPARMs usually use slow-responding indexes, but there is no cap on rate adjustments. There is a maximum overall cap, usually ranging from ten to twelve percent, but sometimes higher.

The minimum payment for an FPARM is calculated at the month one rate, and can only be raised by seven and a half percent each year. This allows for negative amortization, and the exceptions to this seven and a half percent per year rule can cause some serious payment shock. The first exception is that every five years the monthly payment is recast to be fully amortizing, meaning that it is raised to a level that would pay off the loan at the current interest rate in the remaining term of the loan. This is calculated without regard to how large a payment will be required, and can lead to a very large increase.

The second exception relates to the negative amortization cap. Once this cap is reached, the monthly payments will be recast to a fully amortizing amount both automatically and immediately. This can be even worse than the scheduled recasting, since you may not have much time to prepare for the increase. Negative amortization maximum amounts usually range from around 110 percent to 125 percent of the loan’s original balance.

Though FPARMs have attractive minimums throughout their early stages, you should be mindful of the risk of large increases when considering one.