adjustable mortgage rate: how can you reduce your risk?
Besides an overall rate ceiling, most ARMS also have "caps" that protect borrowers from extreme increases in monthly payments. Others allow borrowers to convert an ARM to a fixed-rate mortgage. While these may offer real benefits, they may also cost more, or add special features, such as negative amortization.
Interest-Rate Caps
An interest-rate cap places a limit on the amount your interest rate can increase. Interest caps come in two versions:
- Periodic caps, which limit the interest rate increase from one adjustment period to the next; and
- Overall caps, which limit the interest rate increase over the life of the loan.
By law, virtually all ARMS must have an overall cap. Many have a periodic interest rate cap. Let's suppose you have an ARM with a periodic interest rate cap of 2%. At the first adjustment, the index rate goes up 3%. The example shows what happens.
| ARM Interest Rate | Monthly Payment |
| First year @ 10% | $570.42 |
| 2nd year @ 13% (without cap) | $717.12 |
| 2nd year @ 12% (with cap) | $667.30 |
| Difference in 2nd year between payment with cap and payment without = $49.82 | |
A drop in interest rates does not always lead to a drop in monthly payments. In fact, with some ARMS that have interest rate caps, your payment amount may increase even though the index rate has stayed the same or declined. This may happen when an interest rate cap has been holding your interest rate down below the sum of the index plus margin. If a rate cap holds down your interest rate, increases to the index that were not imposed due to the cap may carry over to future rate adjustments.
- posted by Mark Pane @ 7:33 PM 0 comments
