Adjustable Rate Mortgage (ARM) Part 1

Question 1

What does ARM/VRM stand for?

Answer 1

Adjustable Rate Mortgage/Variable Rate Mortgage, or Adjustable Rate Loan/Variable Rate Loan

Question 2

The interest of an ARM varies upward or downwards over the term of the loan, on what conditions?

Answer 2

1. ) Money market conditions.

2. ) Index chosen.

Question 3

How can an ARM benefit a borrower, and the lender?

Answer 3

1. ) An ARM may help a borrower qualify more easily for a home loan or more expensive home.
2. ) For the lender, passes the risk of fluctuation interest rates on to the borrower; and frees the lender from being locked into a fixed-interest rate for the entire life of the loan.

Question 4

With agreement of the lender, a borrower’s payments may stay the same for a specified time with an ARM—true or false?

Answer 4

True

Question 5

What are the 5 components of an ARM?

Answer 5

1. ) Index
2. ) Margin
3. ) Rate Adjustment Period
4. ) Interest Rate Cap/Floor (if any)
5. ) Conversion Options (if any)

Question 6

What is an Index, who chooses the Index, and what is it referred to?

Answer 6

1. ) An Index is an economic measurement that is used to make periodic interest adjustments for an adjustable-rate mortgage.
2. ) The lender chooses the index that will be used.
3. ) Cost of Money

Question 7

What is a fully indexed rate?

Answer 7

It is the combination of the index and the margin.

Question 8

What is the plural for index?

Answer 8

Indices, not Indexes.

Question 9

What disclosure(s) does the index appear in?

Answer 9

The Loan Estimate and the Promissory Note

Question 10

An index will fluctuate because of market forces, what does this do to a borrower’s actual interest rate?

Answer 10

It may cause it to increase or decrease.

Question 11

What are the 5 most common Indices?

Answer 11

1. ) The Constant Maturity Treasury (CMT)
2. ) The 11th District Cost of Fund Index (COFI)
3. ) The London Inter Bank Offering Rates (LIBOR)
4. ) Certificate of Deposit Index (CODI)
5. ) The Bank Prime Loan Rate (Prime Rate)

Question 12

The Margin, or known as Spread, represents what, and is used for what purpose?

Answer 12

1. ) The Margin represents the lender’ operating costs and profit margin.
2. ) Lenders add this number to an index to determine the interest rate of an ARM.

Question 13

Like an Index, the margin will vary throughout the life of a loan—true or false?

Answer 13

False; the Margin is a fixed number that is not subject to change during the term of a loan.
-The Margin can vary greatly between different lenders.

Question 14

Where is the Margin disclosed?

Answer 14

The Loan Estimate

Question 15

How is the Fully Index Rate found?

Answer 15

By adding the index to the margin, lenders calculate the fully indexed rate.
EX: 4.25% Current Index Value + 2.00% Margin = 6.25% Fully Indexed Rate

Question 16

For an ARM what is an Introductory Rate/Start Rate/Initial Rate?

Answer 16

The interest rate on an ARM at closing, and will be in effect for a period of time—depending upon the loan product.

Question 17

What is it called when an introductory rate is lower than the fully indexed rate at the closing?

Answer 17

The Teaser Rate

Question 18

What is the Rate Adjustment Period?

Answer 18

The Rate Adjustment Period is the length of time between interest rate changes on ARMs.

Question 19

Within an ARM, what is an Interest Rate Cap/Adjustment Caps?

Answer 19

A limitation on the amount that an interest rate, that may increase or decrease either at the adjustment date or over the lifetime of the loan.

Question 20

What is the purpose of the Interest Rate Cap?

Answer 20

Helps to eliminate large fluctuations in mortgage payments.

-This helps consumers avoid “payment shock.”

Question 21

What is Payment Shock?

Answer 21

It is when there is a significant increase in the monthly payment on a ARM that may surprise the borrower.

Question 22

What does CAPS do?

Answer 22

CAPS regulate how much the interest rate can increase in a given period.

Question 23

What are three main interest caps?

Answer 23

1. ) The initial Cap
2. ) The Periodic Adjustment Caps
3. ) Lifetime caps

Question 24

What does the Initial Cap do?

Answer 24

It applies to the first rate adjustment period & indicates the number of percentage points that a rate may increase over the start rate.

Question 25

What does the Periodic Cap do?

Answer 25

It is the limit the amount the interest rate can adjust up or down from one adjustment period to the next.

Question 26

What does the Life Cap do?

Answer 26

It sets a maximum number of percentage points that the rate can increase over the start rate for the life of the loan, functioning as a Rate Ceiling.

Question 27

ARMs that are identified with three numbers, do what?

Answer 27

Allows for a higher rate change at the 1st adjustment and then apply a periodic adjustment cap to future adjustments.

Question 28

What do the three numbers that certain ARMs are represented with stand for? For example, 5/2/6?

Answer 28

5% at the first adjustment (the 1st number is the interest rate cap for the 1st adj.).

2% for subsequent adjustable periods (Is the period adj. cap).

6% total over the life of the loan (Is the lifetime interest rate cap.).