Option or minimum payment loans usually offer the borrower of a choice between several different payments. This option is usually available for the first five years of the loan.
An option payment loan usually comes with the option to make the following payments:
regular 30 year payment
interest only payment
A 30 year loan has the highest monthly payment. After this the interest only payment is second in size.
The smallest monthly payment is the minimum payment.
It is important to note that minimum payment rate can go as low as 1% (some lenders have rolled out 0.5% minimum payment rates).
Making the minimum payment can result in “negative amortization”. This is when any shortfall in payment less than the interest-only amount is added onto the principal of the loan. Many borrowers prefer having the lowest possible monthly payment, so they don’t mind this. Also, their equity in the property may rise faster than their loan size, so their equity still increases.
Minimum payments are typically fixed for each of the first five years. The minimum payment size usually increases once a year to a slightly higher level. Often times this is a 7.5% increase in the payment size. This is not a 7.5% increase in the interest rate – just a 7.5% increase in the size of the minimum payment. For example, if the minimum payment is $1,000 in the first year than in the second year the minimum payment is $1,075 ($1,000 * (1+7.5%)).
The following example shows how a $400,000 loan with a 1% minimum rate works:
Loan Amount 400,000
Minimum Payment Rate 1.00%
Loan Note Rate 7.25%
Loan Length (Years) 30
Loan Payment Options
Regular Monthly Payment 2,729
Interest Only Payment 2,417
Minimum Payment 1,287
Negative Amortization Per Month 1,130
Maximum Loan Size
Maximum negative amortization limit 115.00%
Maximum negative amortization loan size 460,000
Months of minimum payments till limit reached 53
Number of years you plan to keep the house 4
Loan balance if you make only minimum payments 454,245
Value of house when you sell 550,000
Projected loan to value ratio 83%
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