Casino Connection Atlantic City

Option ARMs: Let the Buyer Beware

If you opt for this type of loan, make sure it’s the right type—a COSI

by Rick Anderson

Here's a typical scenario if you work the swing shift or the graveyard shift: You come home late, you eat dinner; maybe you can’t go right to bed so you turn the TV on and there’s yet another real-estate infomercial course with glowing testimonies of fabulous wealth for part-timers.

I’ve seen my fair share and purchased my fair share, but to set the record straight, there is money to be made, even in today’s impacted housing market.

“Option ARMs” are one of those ways, but you have to be careful. “ARM” stands for “adjustable-rate mortgage”—that is, a mortgage where the interest rate is not fixed, but fluctuates based on a couple factors, but usually tied to the Prime Rate. An Option ARM means that the buyer normally has four options on how to make payments.

Some TV infomercials offer investment courses that supposedly help you use an ARM to refinance your home so you can leverage its equity and buy other properties. How does that work? Through “deferred interest.” In other words, the ARM has graduated payments starting at the minimum and gradually reaching the fully indexed rate. The ARM defers interest and gives the borrower (you) a greater cash flow compared to a conventional fixed-rate mortgage. And with cash flow, you can buy another property, maybe a rental.

So far so good, right? But there's a problem.

Because the interest rate is adjustable, it “adjusts” to the whims of the real-estate market, so your payments can go up. And because you could opt for “interest-only” or just pay the minimum, you can be lulled into thinking that you’re keeping within your budget when in fact the loan’s not getting paid off. Deferred interest still has to be paid, eventually.

As an Option ARM, I like the Cost of Savings Index, or COSI loan, because its yearly interest is charged to whatever the loan’s current principal balance is, so as the principal gets paid down, that deferred interest gets zapped as well. Plus, the COSI’s interest rate uses the most stable index possible aside from a standard fixed rate—the Cost of Savings Index.

That index is the same as what the banks pay its money market and checking account depositors. Plus, the COSI re-amortizes 26 times a year; it has 2 percent interest “start rate” on investment properties—less so on privately owned—and each year’s bi-weekly payments are capped so as not to exceed 7 percent of last year’s bi-weekly payments.

I give the COSI “two thumbs up!”