Key Elements of ARM Loans

Questions to ask lender regarding ARM loan:

Start Rate/Introductory rate

• The initial interest rate charged on the loan
• Only good for designated period
• Often reduced as borrower incentive

Margin

• A fixed interest rate that is determined by the lender
• Added to the index value to determine new mortgage rate
• The margin can vary widely from lender to lender (2 - 3.5%)

Adjustment period

• Period of time between interest rate changes
• When lender determines rate change by adding index & margin
• Can be as frequent as a month
• Can be as frequent as several years

Rate Cap/Payment Cap

• Periodic Rate Cap (limit on how much rate can increase each adjustment)
• Lifetime Rate Cap (limit on how much rate can increase for the life of the loan)
• Periodic Payment Cap (limit on how much loan payment can increase each adjustment)

Index

• Gauge that measures interest rate levels in the economy
• Added to lender's margin to determine new mortgage rate
• The most common index is the average weekly yield on the one year T-bill
• Other common indexes are the 6 month CD, Cost of Funds and LIBOR

Negative Amortization

• Can occur on ARMs with payment caps
• Occurs when capped mortgage payment cannot cover loan's interest costs
• Unpaid interest gets added to outstanding loan balance