ARMs
Components of ARMs
- index - margin - rate adjustment period - interest rate cap/floor (if any) - conversion option (if any)
what are some common indices?
- the Constant Maturity Treasury (CMT) - The 11th District Cost of Fund Index (COFI) - The London Inter Bank Offering Rates (LIBOR) - Certificate of Deposit Index (CODI) - The Bank Prime Loan Rate (Prime Rate)
what are the three main interest caps in an ARM?
-initial cap -periodic adjustment caps -lifetime cap
types of ARMs:
-interest-only ARMs -payment-option ARMs -convertible ARMs -hybrid ARMs
An ARM has a start rate of 4% with a 2/6 cap. What is the max increase per adjustment and the max increase over the lifetime of the loan? What is the ceiling and the floor of this loan?
2%; 6% 10%; 2%
in an ARM with a cap of 5/2/6 what are the adjustments and caps?
5% - first adjustment 2% - periodic adjustment cap 6% - lifetime interest rate cap
ARM
Adjustable Rate Mortgage
fully indexed rate
In an ARM, the interest rate indicated by adding the current index value and the margin.
the specific index used to determine the rate adjustments must be disclosed to a potential borrower on the:
Loan Estimate
rate adjustment period
The length of time between interest rate changes with an ARM
rate floor
The lowest interest rate to which an ARM may adjust
option ARM
Type of ARM that lets borrowers choose from several repayment options each month; can lead to negative amortization and recasting
payment shock
a significant increase in the monthly payment on an ARM that may surprise the borrower
Other names for ARMs
adjustable-rate loan, variable rate loan
what is another name for interest rate caps?
adjustment cap
what is an index
an economic measurement used to make periodic interest adjustments for an adjustable-rate mortgage
interest-only ARMs
an interest-only ARM (IO) allows payment of interest only for a specified number of years (typically between 3 and 10 years; allows borrower to have a smaller monthly payment for a period of time
hybrid loans (ARM)
combines features of a fixed-rate loan with those of an adjustable-rate loan; good for lenders planning on selling or paying off their homes in a few years; ARMs feature typically lower than fixed-rate loan; initially fixed rate for period of 3, 5, 7, or 10 years
index is often referred to as the:
cost of fund
the margin is a _____ number that is not subject to change during the term of a loan
fixed
a fully indexed rate is the combination of the:
index and margin
what is the plural of index?
indices
all introductory rates, whether teaser or not, are set by the ___________
lender
in ARMs, the ____ chooses the index that will be used
lender
the margin represents the:
lender's operating costs and profit margin
interest rate cap
limitation on the amount that an interest rate may increase or decrease either at the adjustment date or over the lifetime of the loan
the margin is disclosed on the
loan estimate
convertible ARM
may have a conversion option from an ARM to a fixed-rate mortgage without having to refinance; lender typically charges one time fee for conversion; interest rate is based upon current prevailing rate
index is _____ under control of lender, determined by index
not
recasting
option ARM payments are typically adjusted every 5 years; lenders do this by amortizing the higher principal balance created by the addition of interest (neg. am.); amortizes the loan so it can be paid in full by the end of the loan term
the index appears on the loan estimate and the ________________ when the loan goes to closing
promissory note
life cap
sets a max number of percentage points that the rate can increase over the start for the life of the loan functioning as the rate ceiling
margin can also be referred to as a:
spread
what are other names for the introductory rate?
start rate or initial rate
initial cap
the initial cap applies only to the first rate adjustment period and indicates the number of percentage points that a rate may increase over the start rate
introductory rate
the interest rate on an ARM at closing is called the introductory rate, and it will be in effect for a period of time ranging from one month to 10 years depending upon the loan product
What does it mean to have a hybrid loan of 2/28?
the loan is fixed for 2 years and adjusts for 28 years
Margin
the margin is the number that a lender adds to an index to determine the interest rate of an ARM
periodic cap
the periodic cap limits the amount the interest rate can adjust up or down from an adjustment period to the next
what is a teaser rate?
when the introductory rate is lower than the fully-indexed rate at time of closing