Additionally, there are some safeguards built in to these loans to reduce your risk exposure from rising interest rates.  These safeguards are generally:

• A Fixed Interest Rate for an initial 1-month period
• A Minimum Payment Amount that Adjusts on an Annual Basis
• A Payment Change Cap*
• A Lifetime Interest Rate Cap

The Payment Change Cap limits how much your minimum monthly payment can increase or decrease from the previous minimum payment.  You should note that many lenders provide an exception in your note so this cap is not in effect during certain periods of your note.

Option 1 - Minimum Payment

This option (known as the Minimum Payment Option) provides the greatest monthly cash flow savings.  Your payment will change annually and is initially calculated using the initial interest rate for the first 12 months.  After the first year, this payment is usually re-calculated annually and based on the outstanding principal balance, remaining term and current market rates.  Before applying for an option arm loan make sure to ask what index your loan is based on and the margin (see below).  A Payment Change Cap* is in effect with most programs usually capping any change to within 7.5% of your original payment (annual increase or decrease)

Option 2 - Interest Only Payment

Just like the popular interest only mortgage programs this option helps the homeowner prevent any avoid deferred interest by paying the minimum monthly payment plus any additional interest accrued during the month. 

*Not offered if the interest only payment is less than the minimum payment due.

Option 3 - 15 Year Fixed Rate Payment

This option allows a consumers to apply the largest contribution towards principal and term reduction.  The payment required to satisfy this is calculated by amortizing your loan based on a 15-year term from the first payment due date.

* This option is offered only on 30 or 40-year term option arm programs and is no longer present once the loan reaches its 16th year.

Option 4 - 30 Year Fixed Rate Payment

This is the fully amortized payment based on a 30-year loan and is calculated each month based on the prior month's interest rate, loan balance and remaining term.  The biggest advantage to this payment option is that the payment pays all of the interest due and reduces your principal.

*Not offered if the interest only payment is less than the minimum payment due.

• What Index is used?  This will help you determine what financial index is used as a base for calculating your interest rate. Such indices include MTA, COFI, COSI and the LIBOR index.
   
• What is the Margin?  By adding the margin to you loan's current index rate you can know calculate what the real rate of interest is for the loan program in today's market.
   
• Can You Make Extra Principal Payments?  Be very careful and make sure you ask this question.  Mortgage lenders and brokers earn quite a large sum of money for attaching a prepayment penalty to these programs so if you are against having a prepayment penalty make sure you take the time to ask. (Most lenders will allow you - even with the prepayment penalty - to still pay up to 20% a year without triggering the penalty clause).