An ARM typically starts with a lower rate than a fixed-rate mortgage during the initial period. After the initial period, the rate adjusts based on a financial index (like the Treasury rate or SOFR) plus the lender's margin. ARMs have rate caps that limit how much the rate can change: periodic caps limit each adjustment, lifetime caps limit total increases over the loan life, and payment caps limit monthly payment changes. A 5/1 ARM means the rate is fixed for 5 years, then adjusts annually.
A borrower gets a 5/1 ARM at 5% initial rate with a 2% periodic cap and 6% lifetime cap, margin of 2.5%. After 5 years, if the index is 4%, the new rate would be 4% + 2.5% = 6.5%. But the periodic cap limits the increase to 7% (5% + 2%). The rate can never exceed 11% (5% + 6% lifetime cap).
Know the components: Index + Margin = Fully Indexed Rate. Understand the three types of caps: periodic (per adjustment), lifetime (total increase), and payment cap. A common exam question: "What is the maximum rate?" Answer: Initial rate + lifetime cap. The margin stays the same throughout the loan.
Related Terms
Related Concepts
In the context of foreclosure, a deed transfers ownership of the foreclosed property to the new owner, typically the buyer at a foreclosure sale.
A trustee sale is a type of foreclosure where a trustee, appointed under a deed of trust, sells the property at auction to satisfy the debt.
Foreclosure is the legal process by which a lender takes possession of a property when a borrower fails to make mortgage payments. It allows the lender to sell the property to recover the outstanding debt.
A conventional loan is a mortgage that is not insured or guaranteed by a government agency such as the FHA, VA, or USDA. It is originated and funded by private lenders and may be conforming or non-conforming.
An FHA loan is a mortgage insured by the Federal Housing Administration that allows lower down payments and credit scores than conventional loans. It is designed to help first-time homebuyers and borrowers with limited resources.
Frequently Asked Questions
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