A potential risk associated with Pay Option ARM is possible negative amortization. Negative amortization occurs when over time the loan balance is more than the original loan amount. When a borrower makes minimum payments, which is less than the interest accrued for the month, the interest left unpaid is added to the loan principal. Instead of pay down the principal, the homeowner can end up owing more than what he borrowed. In a real estate market where home values are unchanged or even depreciating, negative amortization can be disastrous.

Option ARM's may cause "Negative Amortization" only if the appreciation is less than 3% per annum. If one is able to take the difference between the minimum payment and the full interest payment and put this amount into a tax free investment vehicle then one would be able to payoff one's mortgage that much faster.