When comparing ARM products, an MLO shows a borrower a 5/1 ARM with a 2% annual cap and 5% lifetime cap versus a 7/1 ARM with a 1% annual cap and 6% lifetime cap. Both start at 3.5%. What is the maximum rate the 5/1 ARM could reach in year 7?
Correct Answer
A) 8.5%
For the 5/1 ARM starting at 3.5% with 2% annual caps and 5% lifetime cap: Year 6 (first adjustment) could go to 5.5%, Year 7 could go to 7.5%. However, the lifetime cap limits the rate to 8.5% (3.5% + 5%). Since 7.5% is below the lifetime cap, the maximum rate in year 7 would be 8.5% if market conditions warranted the full annual adjustment.
Why This Is the Correct Answer
For the 5/1 ARM starting at 3.5% with 2% annual caps and 5% lifetime cap: Year 6 (first adjustment) could go to 5.5%, Year 7 could go to 7.5%. However, the lifetime cap limits the rate to 8.5% (3.5% + 5%). Since 7.5% is below the lifetime cap, the maximum rate in year 7 would be 8.5% if market conditions warranted the full annual adjustment.
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