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An ARM uses the 1-year Treasury index, which is currently at 2.1%. The margin is 2.75%, but the loan has a floor rate of 5.5%. What rate will the borrower pay?

Correct Answer

D) 5.5%

The fully indexed rate would be 2.1% (index) + 2.75% (margin) = 4.85%. However, since the loan has a floor rate of 5.5%, and the calculated rate is below this floor, the borrower must pay the higher floor rate of 5.5%. Floor rates protect lenders from extremely low interest rate environments.

Answer Options
A
2.1%
B
2.75%
C
4.85%
D
5.5%

Why This Is the Correct Answer

The fully indexed rate would be 2.1% (index) + 2.75% (margin) = 4.85%. However, since the loan has a floor rate of 5.5%, and the calculated rate is below this floor, the borrower must pay the higher floor rate of 5.5%. Floor rates protect lenders from extremely low interest rate environments.

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