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This is the final post in a series.

Most of the time costs associated with the option ARM are greater than those for a reverse mortgage. The closing costs tend to be similar amounts, but the interest rates on option ARMs average about 1% higher. Far more costly is the fact that you must cash out all the money at once from an option ARM rather than being able to take it out of a line of credit on an as-needed basis. The line of credit allows the loan interest to accrue more slowly since you keep the mortgage balance lower for a longer period of time, so that the loan interest accrues against a smaller balance. The option ARM only partially offsets this factor in that the homeowner pays a portion of the interest each month.

Common wisdom would indicate that seniors should look before they leap into an option ARM. It is really designed for working people who are willing to trade some of their equity for the privilege of freeing up some monthly cash flow for a period of time. But reverse mortgages for seniors are a far better choice in most cases.

In comparing these two loan products, there are several factors to consider. For some, the option Arm would be like a ticking time bomb – it is only a matter of time before the low monthly mortgage payment would be replaced by a large monthly payment. If the senior does not have an abundance of income and wants to stay in their home for many years to come, then the option ARM would be a poor choice. On the other hand, the reverse mortgage carries the guarantee of no mortgage payments for as long as the homeowner lives in the home.

Qualifying for the reverse mortgage is much easier than qualifying for the option ARM. The reverse mortgage does not require any income, assets (other than home equity) or minimum credit score. The option ARM does require those items, even if they only must be “stated” on the forms by the borrower. Caution: never consider lying about the amount of income or assets. Despite what an eager broker might say, such an action carries potential loan-fraud consequences.

Coming up, Part 5

The option ARM mortgage has many names, including “pay-option mortgage”, “negative amortization loan”, “pick-a-payment”, or “deferred-interest loan”, to name a few. Similar to the reverse mortgage, it allows a homeowner to pull out a lump sum of equity, while only taking on a relatively small mortgage payment. A few differences are that the homeowner can be of any age, but the money must be taken as a lump sum (no credit lines). Although the interest rate is generally between 6% and 12%, the borrower only makes monthly payments for between 2% and 5% annually of the loan balance. This gets paid monthly (take 2% to 5% and divide by 12). For example, if the payment is 5% and the interest rate is 8% (a common scenario), then the interest that is not being paid is 3%. (8% minus 5%). Similar to a reverse mortgage, the lender allows that 3% of unpaid interest to be repaid at a later date by adding it to the principal balance of the loan. Thus, the loan balance grows over time, even though payments are being made. But there is a limit on how much the loan balance is allowed to grow. Depending upon the lender, once it reaches around 110% to 115% of the original loan balance, a full mortgage payment must be made.

Part 4 will follow in a couple days.

To start, let's define each type of loan. The reverse mortgage is a home loan that allows people over the age of 62 to pull out some of their home equity to use for any purpose that they want. The loan may be kept until the homeowner(s) either sell the home or permanently move out. An aspect of this mortgage that is very appealing for many seniors is it does not require any monthly mortgage payment whatsoever for the life of the loan. A reverse mortgage is similar in many ways to a line of credit in that there is a credit limit and the ability to pull cash out and put it back in. The borrower does not pay the monthly interest that accrues as he/she goes. The lender cannot even ask the homeowner for any payments as long as they live in the home, but instead the interest gets added to the principal balance. At the end, the lender collects the total amount that it has lent to the borrower, which includes principal plus interest.

This is the second post in a series. To be continued . . .