ARMs

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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


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