Information needed to assess ARMs | The Mortgage Professor's Explanation |
1. The index to which your ARM rate is tied. | On a rate adjustment date, the rate is set at the index plus margin (5), subject to any caps (6,7,8). |
2. The initial interest rate | This is the interest rate that is always quoted on an ARM. |
3. The period for which the initial interest rate holds | This period ranges from a month to 10 years. |
4. The rate adjustment period after the initial fixed-rate period is over | On ARMs with initial rate periods of 1 year or longer, this is almost always 1 year. On ARMs with initial rate periods shorter than 1 year, the subsequent rate adjustment period is almost always the same as the initial rate adjustment period. |
5. The margin that is added to the index value on a rate adjustment date to determine the new rate | This generally ranges from 2 to 3%. |
6. The rate adjustment cap limiting the size of the first rate adjustment | This generally ranges from 1 to 5%. |
7. The rate adjustment cap limiting the size of subsequent rate adjustments | This generally ranges from 1 to 2%. |
8. The maximum interest rate over the life of the loan | This is usually 5 or 6% above the initial rate. |
9. Points | Upfront charge expressed as a percent of the loan. |
If the ARM allows negative amortization, you should have the following additional information: | |
10. The initial payment is calculated (select one):
a. At the initial interest rate. b. At the initial interest rate but interest only. c. At another interest rate (specify) |
On ARMs that allow negative amortization, the initial payment is not necessarily calculated using the initial interest rate. |
11. The initial payment period | On ARMs that allow negative amortization, the period for which the initial payment holds is not necessarily the same as the period for which the initial rate holds. On monthly ARMs, the rate adjusts every month but the payment adjusts every year. |
12. The payment adjustment period after the initial period ends | It is usually but need not be the same as the initial payment period. |
13. The payment adjustment cap, if any | Usually 7.5% per year, if there is one. |
14. The negative amortization cap, if any | On ARMs that allow negative amortization, there is always a limit on how large the negative amortization can get, or how long it can last. Some ARMs set a cap on the loan balance as a percent of the original balance, usually 110% or 115%. |
15. The payment recast period, if any | Another way of limiting negative amortization is to require a periodic recast of the payment. A recast recalculates the payment to make it fully-amortizing, using the current loan balance, interest rate and period remaining to term. |