All caps arent created equal

ARM caps limit how high the lender can lift your monthly mortgage payment. Many ARMs set their caps at 2/6. With these caps in place, the lender could not increase your loan's interest rate more than two percentage points at a time nor more than six percentage points throughout the life of the loan. However, also investigate:

  • The period of adjustment. Loan payments may adjust monthly, quarterly, semi-annually, or annually; or payments may stay fixed for 3, 5, or 10 years and then adjust annually or more frequently.
  • Negative amortization (neg-am). Your ARM's at 5 percent; interest rates shoot up. Your loan's index jumps by 3.5 percent. "Whew!" You think, "Thank goodness for my yearly cap. The lender can raise my loan's interest rate only two points: from 5 to 7 percent." True, but if that loan shackles you with negative amortization, you don't escape the pain of a higher rate—you merely postpone it. The lender adds the interest deficiency (1.5 percent) to your outstanding mortgage balance. Instead of owing less, you owe more.
  • The baseline rate. Your ARM may actually include two initial rates: the teaser rate (say 4.0 percent), and the contract rate (say 5.5 percent). Which of these rates provides the baseline for adjustments? If your lifetime cap is 6 percent, how high could your rate go: 10.0 percent (6.0 + 4.0) or 11.5 percent (6.0 + 5.0)? A similar question also applies to the loan's periodic adjustments. If your payment caps limit annual increases by two points, what base does the lender stat with? Contract rate, or teaser rate?
  • Can borrowers do better than 2/6 caps? Yes, they can. Although conventional ARMs (Freddie/Fannie) typically carry 2/6 caps, FHA/VA

ARMs apply 1/5 caps. You may even find periodic caps as low as .5 percent and lifetime caps of 2 or 3 percent.

Nearly all ARMs include caps of one sort or another. But to compare ARMs, calculate just how much protection those caps really give you. All caps are not created equal.

0 0

Post a comment