1.25% Option Loans—Pros and Cons
Option loans are not right for everyone who is looking to purchase a home. Here we will explain some of the pros and cons of financing through a 1.25% option loan.
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Option loans are of the greatest benefit to people with fluctuating or temporarily-low incomes. College students who are only able to work part-time may be able to afford their own home by paying the minimum payment while in school. By the time that the mortgage converts to a traditional adjustable rate mortgage, they will have graduated. They should then be able to afford the fully amortized payments. Additionally, people with fluctuating incomes may be able to pay more when their income is higher and less when their income is lower. Though it may average out to be the same amount they would have paid monthly with fully amortized payments, it saves them the hassle of trying to save money to pay their mortgage payments during their slow months.
Option loans can also be beneficial to people who do not plan to own their home for a long period of time. Because they are most likely not interested in earning equity in the home, they can simply pay the interest payments and resell the home for the principal amount. Young professionals and people who are planning to relocate within a few years might find that this is a better option than renting a house, and it is often less expensive.
The problem with paying the minimum payment on your mortgage each month is that the interest you are not paying is added to your principal amount. You are then charged interest on your interest. Adding to your principal amount every month in this way can easily cause you to end up owning more than your house is worth.
Paying the interest-only or minimum payment on your mortgage does not earn you equity in the home. Borrowers who are seeking equity will be better off in a traditional mortgage.
Option loans do not have the interest caps that traditional loans use in order to protect consumers. This means that if the index rate were to jump, you would still be responsible for that rate plus your margin.
Option loans also have very complicated terms. This often encourages predatory lenders to prey on uneducated consumers. Speak with a licensed mortgage broker before entering into any mortgage to make sure that you choose the loan that is right for you.
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