Monday, Dec. 31, 2007 | Regarding Rich Toscano’s article on option arm loans, there is a lot of alarmist information in it. Just because the initial article appeared in the L.A. Times doesn’t make it valid.
This type of loan was introduced in the mid-seventies by Home Savings S&L and Great Western S&L and shortly after, World Savings S&L. They were good loans then and now. Virtually all apartment loans are of the same type. That said, they are not the ideal loan for everyone. Neither is a fixed rate loan. The loan used should fit the borrower’s need.
The option arm, as it’s called now, has a payment which adjusts annually, with a cap typically of 1 percent of the payment amount. The interest rate adjusts annually based on the sum of the margin, typically 2.5 percent and the index, which will be one of a number of widely accepted and published interest rates, such as LIBOR, six-month T-Bill, or the 11h district cost of funds.
So the payment over time may not be enough to cover the interest rate, and that will lead to negative amortization. If that neg-am creeps up to an amount exceeding 5 percent of the original loan amount the loan is re-amortized and a new payment is calculated, with the same 1 percent annual payment cap. There is a life of loan cap on the loan size, typically 11 percent.
Some of these loans have an additional feature which permits interest-only payments for a period of time, after which the loan begins to amortize. Hence, “option arm.” The borrower has an option every month.
The loan is a cash flow management tool. It has worked well for all parties involved for 30+ years.
I liken loan types to surgeons’ scalpels. Not every one is the right one for every borrower or procedure. Does the surgeon reject all the other scalpels forever if only one works for that specific procedure? Of course not.
Neither should the lender/borrower.