FHCE2100 Test 3 Issue #6

Periodic rate cap

(*x*/y) in a given interval (time period), the interest rate can only change by x% points

Lifetime rate cap

(x/*y*) maximum the interest rate can ever change (up or down). adding y% will be the highest interest rate the ARM could ever have. subtracting y% will be the lowest interest rate the ARM could ever have

Hybrid ARM

mix of a fixed-rate period and an adjustable-rate period. The interest rate is fixed for the first several years of the loan; after that, the rate could adjust annually. 5/1 hybrid ARM 5= # of years fixed 1= 1 yr ARM after the first fixed time period Pros: benefit from lower rate if borrower doesn't expect to be in the home much longer than the fixed-rate period Cons: after fixed rate period the borrower assumes the interest rate risk, beware of prepayment penalty if you plan to refinance after fixed rate period

Growing Equity Mortgage

pre-payment is automatically planned; applies to conventional or fixed rate mortgage Advantage: allows homeowner to pay mortgage down more quickly (equity grows faster) Disadvantage: less flexible than just prepaying your fixed rate mortgage

Payment-option ARM

ARM that allows you to choose among several payment options each month (tradition amortizing payment of principal and interest, interest-only payment, a minimum payment that may be less than the amount of interest due that month (GPM aka negative amortization)) Advantages: flexible to deal with economic circumstances Disadvantages: potentially lose much of tax advantages (determined by which method use predominantly)

Interest-only payment ARM

ARM that allows you to pay only the interest for a specific number of years. After that, you must repay both the principal and the interest over the remaining term of the loan. Pros: benefit from lower payment if borrower doesn't expect to be in the home much longer than the interest only period Cons: after interest-only period, the borrower assumes the principal and interest payments--- much higher payment. Not accumulating any equity during the interest-only period (does not change the amount you owe on your mortgage) b/c not pay down principal at all

Adjustment Interval

Also known as frequency of rate change Tells you how often the ARM mortgage interest rate can change As often as ever 3 months to 3-5 years Typically ONE year

Margin

constant over the life of loan--- FIXED Extra amount that lenders add is FIXED %

Adjustable Rate Mortgages

Interest rate is dependent on index and margin. Advantages: initial interest rate lower; initial monthly payment lower; some long-term tax advantages; more available during certain periods of time; rate caps reduce uncertainty; when interest rates are high and you expect rates to drop, this avoids the cost of refinancing to get lower rate Disadvantages: uncertainty about future interest rate and monthly payments, may be higher total cost than fixed if rates increase

Negative Amortization

Monthly payment does not cover all the interest owed. The lender adds this difference to the balance of the mortgage. Means increasing the loan balance. Occurs when the mortgage interest rate rises but the mortgage payment remains the same.

payment cap

On an ARM, the limit on the monthly payment increase that may result from a rate adjustment

Fixed rate

The tradition type of mortgage, in which both the rate of interest and the monthly mortgage payment are fixed over the full term of the loan. *Burden is upfront*. Advantages: stable payment, long-term tax advantage, shield from future interest rate increases Disadvantages: Interest rate higher, monthly payment higher, no benefits if market interest rates decrease, limited availability during some periods

graduated payment mortgage

a mortgage that starts with unusually low payments that rise over several years to a fixed payment Advantages: lower initial monthly payment, families may qualify for this when not others, known/moderate increase in monthly payments Disadvantages: higher total interest costs over life of loan, no benefits if interest rates decrease, negative amortization

Amortization

means reducing the loan balance (the amount you owe the lender) the reduction of a loan balance through payments made over a period of time

Index

varies over the life of loan; measure of interest rates (cost of money) generally-- baseline that captures the movement in interest rates. How quickly vs how slowly they move