A 5/1 ARM starts at 3.5% with caps of 5/2/5 and a 3.0 margin. At the fifth adjustment the index stands at 7.2%. If the rate immediately before this adjustment is 8.0%, what rate applies after the periodic and lifetime caps are considered?
Correct Answer
D) The rate is 8.5%: the lifetime cap holds it to 5 over the start rate
D. The lifetime ceiling limits the adjusted rate to 8.5%. Index plus margin is 7.2% + 3.0 points = 10.2%. The later-adjustment cap allows 8.0% + 2 points = 10.0%; the lifetime ceiling is 3.5% + 5 points = 8.5%. The tighter applicable ceiling controls. Scope and exceptions: These are the stated note terms, not universal ARM caps. This is a later adjustment, so the initial-adjustment cap is not applied again. A rate calculation alone does not provide the monthly payment. Source: Subsequent and lifetime 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
D. The lifetime ceiling limits the adjusted rate to 8.5%. Index plus margin is 7.2% + 3.0 points = 10.2%. The later-adjustment cap allows 8.0% + 2 points = 10.0%; the lifetime ceiling is 3.5% + 5 points = 8.5%. The tighter applicable ceiling controls. Scope and exceptions: These are the stated note terms, not universal ARM caps. This is a later adjustment, so the initial-adjustment cap is not applied again. A rate calculation alone does not provide the monthly payment.
Why the Other Options Are Wrong
Option A: The rate is 12.2%: the lifetime cap is measured from the index instead
It measures the lifetime limit from the index instead of the initial rate.
Option B: The rate is 5.5%: the periodic cap of 2 limits each later adjustment
It incorrectly adds the periodic cap to the original rather than previous rate.
Option C: The rate is 10.2%: the fully indexed rate of index plus margin applies
It ignores both applicable caps.
Exam Tip
For later resets, compare the indexed rate, previous-rate cap and lifetime ceiling.
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