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The borrower adds $54,200 of debt in five years with the option ARM vs. a total payment savings of $10,400. The borrower’s principal balance after the first year is $9,500 more than with the option ARM. The LTV increases to 91 percent, assuming flat housing prices, which potentially limits refinancing options. In the sixth year, the recast monthly payment on the option ARM also would jump to $2,789 vs. the $1,916 for the interest-only 5/1 hybrid, assuming a flat index.
Some borrowers who select the hybrid-ARM product expect a move within five years, a housing appreciation or increased income potential. A slight deviation in the interest rates, or property-value depreciation, however, can skew these borrowers’ plans, and they could face a net loss.
Borrowers such as these demonstrate that the challenge is not necessarily the loan product itself; it’s whether the product is appropriate for the borrower. An aggressive lending environment combined with an economic slowdown could damage the housing market and hurt some borrowers. Others, who could deal with payment changes from the worst-case scenario, could find an ARM to be the best long-term fit.
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