Posted in Finance, Accounting and Economics Terms, Total Reads: 79
Definition: Flexible Payment ARM
Flexible Payment ARM provides a choice of payment options given to the holder of Adjustable Rate Mortgage (ARM). The buyer of Flexible Payment ARM, is given an option to choose their payment option from among 4 options.
The most commonly chosen option is minimum monthly payment which is essentially the negative amortization option meaning the principal balance of the loan increases due to the minimum payment made which is unable to cover the interest amount of the loan. But it provides the buyer a reduced load on the availability of money/capital because of the minimum monthly payment that needs to be made. But in such payment there is generally a cap to negative amortization above which the principal amount cannot rise. Hence the flexible payment Arm provided a flexibility to the buyer of Adjustable Rate Mortgage. There are obvious advantages and disadvantages to the Flexible Payment ARM.
Negatives: While it is itself Adjustable Rate Mortgage, buyer sometimes confuse the minimum payment method as an avoidance of interest, which is not the case, as the interest payments is still accumulated that piles up the principal balance.
Positives: Buyer can divert the funds to a more important/crucial use during the initial years of payment of minimum payment option. After when it becomes stable, he can pay up the premium for his ARM.
For Example: A person buying a Flexible Payment ARM with loan amount of $ 1, 00,000, can chose his payment option from the 4 different choices offered below.
15 year term payment: $5000
30 year term payment: $4000
Interest Only Payment: $3000
Minimum monthly payment: $2000
If he chooses to make Minimum monthly payment as the payment option. He will have to pay $2000 monthly which is the minimum amount he can pay. Suppose the initial ARM interest rate for 5 year period is 3%. So he can save ($15927-$2000) $13927. But this saving is not actual, as the short amount of interest is added back to the principal, thereby increasing principal. Although this amount can be used by the person for these initial 5 crucial years for a different purpose which he thinks is necessary at the current stage.