A note describes its caps as 2/2/6 on a 5/1 ARM starting at 4.75%. What do the three numbers in this ARM cap notation represent?
Correct Answer
C) First adjustment 2 points, each later one 2, and 6 over the start rate
C. Initial cap 2 points, subsequent cap 2 points, lifetime cap 6 points. Read the notation in initial/subsequent/lifetime order. With a 4.75% initial rate and a six-percentage-point lifetime increase cap, the ceiling is 10.75%. Scope and exceptions: These are the contract’s stated values, not mandatory caps for every ARM. The actual adjusted rate also depends on index, margin and other note terms; a floor can differ from the upward lifetime limit. Source: Initial, subsequent and lifetime adjustment caps — https://www.consumerfinance.gov/ask-cfpb/what-are-rate-caps-with-an-adjustable-rate-mortgage-arm-and-how-do-they-work-en-1951/
Why This Is the Correct Answer
C. Initial cap 2 points, subsequent cap 2 points, lifetime cap 6 points. Read the notation in initial/subsequent/lifetime order. With a 4.75% initial rate and a six-percentage-point lifetime increase cap, the ceiling is 10.75%. Scope and exceptions: These are the contract’s stated values, not mandatory caps for every ARM. The actual adjusted rate also depends on index, margin and other note terms; a floor can differ from the upward lifetime limit.
Why the Other Options Are Wrong
Option A: Adjustments of 2 points a year until the rate is 6% above par
Caps limit changes; they do not require annual two-point increases or use an undefined par baseline.
Option B: First adjustment 2 points, each later one 6, and 2 over the start rate
It swaps the subsequent and lifetime limits.
Option D: First adjustment 2 points, each later one 2, and 6 over the index
The lifetime increase is measured from the initial rate, not a changing index.
Exam Tip
Cap notation limits rate movement; it is not a forecast of increases.
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