<p>An Option Adjustable-Rate Mortgage (Option ARM) is a type of mortgage that offers borrowers the flexibility to choose their monthly payment amount within certain limits, while also featuring an adjustable interest rate.</p>

<h2>How It Works</h2>
<p>The Option ARM has a base interest rate that adjusts periodically, typically every one, three, five, seven, or ten years. Borrowers can choose from several payment options each month:</p>
<ul>
  <li><strong>Minimum Payment:</strong> Interest only, which is the lowest amount due but does not reduce the principal balance.</li>
  <li><strong>Interest Plus Principal:</strong> A portion of the principal is paid off in addition to the interest, reducing the loan balance.</li>
  <li><strong>Full Payment:</strong> The entire scheduled payment, including principal and interest, is paid.</li>
</ul>
<p>The loan's principal balance may increase if the minimum payment is chosen consistently, as it may not cover the interest accrued.</p>

<h2>Why It Matters</h2>
<p>Option ARMs can be beneficial for borrowers who expect their income to increase over time or who anticipate selling their property before the interest rate adjusts. However, they can also be risky:</p>
<ul>
  <li>If the interest rate increases significantly, the minimum payment may not cover the interest, causing the principal balance to grow.</li>
  <li>Borrowers may face a "reset" period where the interest rate adjusts and the minimum payment increases substantially.</li>
</ul>
<p>For example, during the U.S. housing boom, many borrowers took out Option ARMs, assuming they could refinance or sell their homes before interest rates adjusted. When the housing market crashed, many found themselves with significantly increased payments and negative equity in their homes.</p>