Adjustable Rate Mortgage Interest Terms
Interest rate caps are the interest rate caps that
are available on the majority of most adjustable rate
mortgage (ARM) loans. Interest caps can cushion excessive
adjustments in the interest rate and subsequently the
monthly payment.
There are two forms of interest rate caps: periodic
and overall or lifetime. With a periodic cap, it sets
a limit to the interest rate. The interest rate can
increase for each adjustment period. Prevalently, the
periodic cap is set at two percent. For example, if
on the first adjustment on the index increases by three
percent, the consumer only pays two percent on the periodic
cap and the rate will increase by two percent. Alternatively,
if during the second year of the loan, the index rate
remains the same, the adjustment is due for a second
time. It will inflate by one percent as a result it
will increase by one percent or equivalent to the current
rates, even if the index was static over the past year.
On the other side of the adjustable rate mortgages,
the second type of cap is a lifetime or an overall cap.
The cap assesses a maximum for the interest rate over
the term of the loan. For instance, it the interest
rate was set at seven six percent and the overall cap
is set at four percent, the maximum interest rate would
then be ten percent. Even if the index rate climbs to
14 percent, the homeowner will never pay more than ten
percent on the loan. Conversely, a four percent change
in interest rates can incur a substantial effect on
the mortgage loan payment.
With certain ARM loans, payment caps are utilized.
Opposed to limiting the interest rate, it sets a maximum
to the payments and how they increase in each adjustment
period. In general, payment caps are based on percentages.
If the payment cap is five percent and the home payment
is $1,000, the maximum mortgage payment could increase
is $1,050 for the initial adjustment period. For the
second adjustment, it can increase an additional five
percent to $1,102.50. The negative aspect of the payment
cap is that the interest rate does not modify. The result
of the payment cap can increase at a rate faster than
the payment, therefore, leading to negative amortization.
Negative amortization occurs when the monthly payment
does not cover the interest of the loan. When negative
amortization occurs, the unpaid interest is added to
the principal portion of the loan and accrues interest
all over again. In short, this means that the mortgage
owner will owe more on the loan than the original amount
borrowed.
