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Flexible-payment ARMs bring high rewards, high risks

Borrower beware of 'payment shock' when monthly installments begin to rise
Published on Feb 9, 2004

"Can you explain flexible-payment ARMs, and their pros and cons?" A flexible-payment ARM (FPARM) is an adjustable-rate mortgage that allows (but does not compel) borrowers to make very low initial mortgage payments that rise over time. The major drawback is that those who select the minimum payment option may suffer "payment shock" – a sudden and sharp increase in the payment for which they are not prepared. FPARMs are also very complicated, which creates a danger that borrowers will take them without fully understanding the risks. Borrowers who don't understand FPARMs, furthermore, may overpay, which increases the risk of payment shock. The main selling point of FPARMs is the low payment in the early years. This allows borrowers to buy more costly houses, or use the monthly payment savings to pay down other high-cost debt, make home improvements, invest in the stock market, and on and on. Loan officers and mortgage brokers selling FPARMs have long lists of ways to use the c...

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