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March 17, 2006



You said "There are cases in which option Arms are appropriate and can provide people with financial opportunities that they might not have with any other loan products" and you listed a few, but you missed one other case where an Option ARM is appropriate:

5 months ago we had a home to sell in Southern California and were wanting to purchase a home in Oregon. Once the California home was sold (even in a worst case "the bubble has burst" scenario) we'd have enough cash to buy the Oregon home outright. And we had just enough cash at hand for a decent downpayment.

But we didn't want to be in the position of making weak contingent offers (nor if accepted then be under pressure to sell our California home quickly at fire-sale prices).

And, we didn't have great cash flow to comfortably carry the full payments on a competitive fixed loan. And didn't want to pay big points on a loan we might not be carrying very long.

We took out an option ARM with zero points and a teaser start rate of 1.2%
That gave us a very low initial holding cost of the loan for a month, then very low "interest only" payments for however many months we needed to sell the California home.
Although the interst (starting at 6%) was bound to go up in a very worst case scenario we wouldn't be into the ARM for more than 6 months (as we could pay it off, or at least pay it WAY down, with the proceeds of the California sale.
So there was no way we could caught in the pincers of rising rates or a balloon payment as e had backing us up the equity of the sale.

In short, as it turned out, we used the ARM to provide us a relatively cheap "Bridge loan" of about $350K for about three months at a total cost way below what an independent person making such a bridge loan would have charged. And as a minor perk, having flawless and "faster than required" payment on the ARM probably improved our already good credit rating.

How's that for another use of an ARM? Probably not the ideal scenario from the lender's point of view, but they did end up making a few thousand dollars for what amounts to a couple of hours of paper shuffling and tying up a bit of their money for about three months.

Caveat: To get zero points we had to accept a one year prepayment penalty.
SO that meant we couldn't COMPLETELY pay off the loan when the cash came in off the California sale. But we COULD (and planned to and did) pay it DOWN -- virtually all of it so we are paying virtually no interest on the tiny remaining balance, which we'll pay off at the one year mark.

Dick Lepre


Interesting case that I had not thought of. Thanks.

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