Interest Rate Caps
Initial Adjustment Cap
An initial adjustment cap limits how much the interest rate can change at the first adjustment period.
Example: If your ARM has a 1% initial adjustment cap, your interest rate may only increase or decrease by a maximum of 1% at the first adjustment period.
Periodic Adjustment Cap
A periodic adjustment cap limits how much your interest rate can change from one adjustment period to the next. Usually a six-month adjustable rate mortgage will have a one percent periodic adjustment cap while a one-year adjustable rate mortgage will have a two percent periodic adjustment cap.
Example: If your loan has a 2% periodic adjustment cap, your interest rate may only increase or decrease by a maximum of 2% per adjustment period.
A lifetime cap sets the maximum and minimum interest rate that you may be charged for the life of the loan. Most ARMs have caps of 5% or 6% above the initial interest rate.
Example: If your loan has a 6% lifetime cap, your interest rate may only increase or decrease by a maximum of 6% for the life of the loan.
Initial adjustment caps, periodic adjustment caps, and lifetime caps make up an adjustable rate mortgage’s cap structure, and are usually represented as three numbers:
Example: 1/2/6 — Initial adjustment cap is 1 %/ periodic cap is 2% / lifetime cap is 6%.
Negatively Amortizing Loans
Because Negatively Amortizing Loans provide payments caps instead of interest rate caps, they limit the amount the monthly payment can increase. However, there is a risk interest rates could potentially escalate to a point where the monthly payment would not cover the interest being charged. If this scenario were to occur, the extra interest charges would be added to the principle of the loan, resulting in the borrower owing more than was initially borrowed. Borrowers are usually allowed to make payments over the loan amount to pay down the mortgage and guard against this scenario.
There are certain times when having a negatively amortizing mortgage could be beneficial. If a borrower were to lose a job or have an unexpected financial emergency a negative amortization option could ease cash flow situation. However, this should only be used as a short-term solution.
Option ARM loans
Option ARM loans allow the borrower to choose the amount to pay toward the mortgage each month. Make a minimum payment, interest-only payment, 30-year amortized payment or 15-year amortized payment. Pay the minimum amount to free up funds for other uses, or make larger payments for faster equity build up. Option Arms offer much more cash flow flexibility but must be used wisely by the borrower. Always consult a qualified loan officer to learn about all of the risks associated with these types of loans. He or she will also be able to offer valuable advice on properly managing your monthly payments.