A California borrower has an adjustable-rate deed of trust loan with a start rate of 4.5%, which is also the current rate at the time of the first adjustment. The loan adjusts annually based on an index plus a margin. The index is currently 3.5% and the lender's margin is 2.75%. The loan carries a 2% periodic cap and an 8% lifetime cap above the start rate. What interest rate will apply at the next adjustment?
Correct Answer
B) 6.25%
The fully indexed rate is calculated by adding the index to the margin: 3.5% + 2.75% = 6.25%. The periodic cap limits the rate increase to 2% above the current rate of 4.5%, meaning the rate cannot exceed 6.50% at this adjustment. Because the fully indexed rate of 6.25% is below the periodic cap ceiling of 6.50% and well below the lifetime cap of 12.50%, the rate adjusts to the fully indexed rate of 6.25%. ARM adjustments move to the fully indexed rate unless a cap prevents it — caps constrain upward movement but do not set the rate.
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