Adjustable-Rate Mortgages
The following are some common examples of caps:
2 / 6: The periodic cap is 2%. The lifetime cap is 6%. In other words, at any one adjustment, the rate may not increase or decrease by more than 2% from the current rate, and over the term of the loan, it may not increase or decrease by more than 6% from the original start rate. 1 / 5: The periodic cap is 1%. The lifetime cap is 5%. 5 / 2 / 5: On a 5/2/5, after an introductory fixed-rate period, the first rate adjustment is limited to a 5% increase above the start rate, with each subsequent adjustment capped at 2%. The loan has a lifetime cap of 5%.
Common balloon programs include the following:
2/28: This loan has a two-year term, though the payment amount is calculated as if the loan were amortizing over a 30-year period 5/25: This loan has a five-year term with payments are amortized over 30 years 180/360: This loan is a 15-year term with payments amortized over 30 years
Balloon Loans
A balloon, or partially-amortized, loan has equal monthly payments required over the term of the loan that do not pay off the loan in its entirety. A balance will be owing at the conclusion of the term (i.e., a balloon payment), which will be due and payable at maturity.
Discount Points / Buy Downs
A discount point is equal to 1% of the loan amount.
The law requires that this amount be passed on to the borrower to assist in paying closing costs. YSP is now more commonly known as
Borrower credit, and if paid in a transaction, must be disclosed on the Loan Estimate and Closing Disclosure.
ARMs require additional disclosures be made to the borrower, regardless of the length of the adjustment period.
One of those disclosures is the Consumer Handbook on Adjustable Rate Mortgages, known as the CHARM Booklet
When discussing adjustable-rate mortgage (ARM) loans, it is important to understand certain terminology.
The interest rate on an ARM is the total of the index rate and the margin.
With implementation of the Ability to Repay Rule,
a borrower must still be qualified for these nontraditional mortgage products based on his or her ability to make the monthly payment according to the fully-indexed rate of the loan and a payment schedule that fully amortizes over the loan's term. A lender may no longer make a mortgage loan based on the borrower's ability to simply pay a loan's initial or introductory rate.
ARM CAPS ARMs have caps, or limits, on adjustments to
a loan's interest rate. these can be both periodic caps and lifetime caps.
HYBRID ARMS Hybrid ARMS have interest rates that are fixed for an initial period of time, after which the rates begin
adjustments. For example, a 3 / 1 ARM has a fixed rate for three years and then adjusts every year thereafter. Other popular hybrid ARMS include the 5 / 1 and the 7 / 1.
The cost of the buy-down is the difference between the monthly payments with and without the buy-down. Typically, the borrower must be qualified
at the note rate rather than at the rate resulting from the buy-down.
A periodic cap refers to the amount by which a rate can increase or
decrease in any one adjustment period.
Option ARMs derive their name from the provision allowing the borrower to choose from several options each month
in terms of making the monthly payment.
Yield Spread Premium
is the amount paid by a lender to a broker or loan originator for closing a loan at an interest rate that is higher than the par rate.
Service Release Premium
is the amount paid to the lender by person acquiring loan on the secondary mortgage market
Fully-indexed rate
is the lender's margin plus the index
Graduated-Payment Programs (GPM)
offers a borrower lower initial payments over the first few years of the loan.
the payment amount gradually increases until it
reaches a point where the remaining monthly installments will fully amortize the loan.
Federal Law does not contain any provision
restricting the minimum adjustment period for an ARM
Discount Points are used to permanently buy down the interest rate,
resulting in a lower rate for the entire term of the loan.
Adjustment Period
the adjustment period is the period of time between rate changes on an ARM.
Index
the index rate is the measure of interest rates based on a specific index.
The borrower may either pay the balloon payment owing or, if the balloon contains a "conditional refinance feature,"
the loan will be converted to a rate which will remain in effect for the effect for the remainder of the term.
Margin
the margin is set by the lender and represents the lender's costs in making the loan. it is expressed as a percentage and does not change over the life of the loan.
The amount of the SRP is based upon
the market value of the loan. if the funding lender and originating broker are different licensees, the SRP is treated like yield spread premium for disclosure purposes.
Start Rate
the start rate, or initial interest rate, may be the fully-indexed rate or a lower rate in place for a specific period of time (often called a discounted rate, introductory rate, or teaser rate)
However, those lower payments do not cover all of the interest due;
the unpaid is added to the principal balance outstanding, resulting in negative amortization.
Temporary buy-downs are used to lower the borrower's monthly payment,
usually for the first one to three years.
the most common options are as follows:
usually very low (for example, 1%). This payment cannot increase by more than 7.5% each year for the first five years. Interest only: For a set period of time, the borrower may pay only the interest due on the loan each month; the payment amount will then increase as the loan terms will require the borrower to begin payment on the principal owing 30-year fixed: The principal balance is amortized over 30 years at the current note rate 15-year fixed: The principal balance is amortized over 15 years at the current note rate