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MLO Licensing > ARMs > Flashcards

ARMs Flashcards

1
Q

What is an ARM?

A

Adjustable-Rate Mortgage

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2
Q

ARM Program 5/1. How long is the rate fixed for and then how often does it adjust?

A

5 years - rate fixed.

Adjust every 1 y ear after.

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3
Q

ARM Cap 2/5. What is the limit the interest rate can go up or down each adjustment? Which is the lifetime cap?

A

2% = limit rate goes up/down each adjustment.

5% is the lifetime cap.

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4
Q

What is the lifetime cap added to?

A

The starting rate. This equals the highest the rate can go over the life of the loan.

Ex. Starting rate is 4% and the lifetime cap is 5%. The highest the rate can go over the lift of the loan is 9%.

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5
Q

What is the ARM margin?

A

The number a lender ADDS to an index to determine the interest rate of an ARM.

It is also the floor, meaning the interest rate cannot go below the margin.

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6
Q

What is the most common index?

A

LIBOR - London Interbank Offered Rate. It changes throughout the day.

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7
Q

What is a Fully-Indexed Rate?

A

Addition of the Index and the Margin.

The borrower is underwritten at the higher of the starting interest rate, or the Fully-Indexed Rate.

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8
Q

An ARM frees lenders from being locked into a ____ interest rate for the entire life of the loan

A

Fixed

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9
Q

In an ARM, interest rates may adjust, according to the terms in the ____, to reflect the current cost of money.

A

Note

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10
Q

What is another term for an Adjustable Rate Mortgage (ARM)?

A

Variable Rate Loan

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11
Q

The interest rate on the ARM only changes if the chosen _____ changes.

A

Index

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12
Q

What are the 5 main components of ARMs?

A
  1. Index
  2. Margin
  3. Rate Adjustment Period
  4. Interest Rate Cap/Floor (if any)
  5. Conversion Options (if any)
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13
Q

What is an Index?

A

An economic measurement that is used to make periodic interest adjustments for an adjustable-rate mortgage.

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14
Q

What is a fully indexed rate?

A

Index + Margin = Fully Indexed Rate

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15
Q

What are the 2 places you’ll see the index?

A
  1. Loan Estimate

2. Promissory Note

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16
Q

The index is NOT under control of the lender. What determines the index?

A

Market conditions

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17
Q

What are the 5 most common indices?

A
  1. CMT (Constant Maturity Treasury)
  2. COFI (Cost of Funds Index)
  3. LIBOR (London Inter Bank Offering Rates)
  4. CODI (Certificate of Deposit Index)
  5. Prime Rate (Bank Prime Loan Rate)
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18
Q

What is the margin also sometimes referred to as?

A

Spread

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19
Q

Is the margin a fixed or variable number?

A

Fixed

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20
Q

What does the margin represent for the lender?

A

Operating costs and profit margins

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21
Q

Does the margin have to be disclosed on the Loan Estimate?

A

Yes

22
Q

Example: What would the fully indexed rate be?

  1. 25% Index
  2. 00% Margin
A

4.25% + 2.00% = 6.25%

23
Q

What is an Introductory Rate on an ARM?

A

The interest rate on an ARM at closing.

It will be in effect for a period of time ranging from 1 month to 10 years depending on the loan product.

24
Q

What are 2 other terms can an Introductory Rate be called?

A
  1. Start Rate

2. Initial Rate

25
Q

What is a teaser rate?

A

When the introductory rate is lower than the fully indexed rate at the time of closing.

26
Q

What is the Rate Adjustment Period?

A

The length of time between interest rate changes on ARMs.

27
Q

What is an Interest Rate Cap?

A

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

28
Q

What can an Interest Rate Cap also be referred to as?

A

Adjustment Caps

29
Q

What is the purpose of Interest Rate Caps?

A

Used with ARMs to limit the number of percentage points and interest rate can be increased during the term of a loan to help eliminate large fluctuations in mortgage payments (avoiding payment shock)

30
Q

What is payment shock?

A

A significant increase in the monthly payment on an ARM that may surprise (shock) the borrower.

31
Q

What are the 3 main interest caps on ARMs?

A
  1. Initial Cap
  2. Periodic Adjustment Cap
  3. Lifetime Cap
32
Q

What is the Initial Cap on an ARM?

A

The initial cap applies only to the first rate adjustment period and indicates the number of percentage points that a rate may increase over the start rate.

33
Q

What are Periodic Caps on ARMs?

A

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

34
Q

Periodic Cap Example:

If a previous period rate was 5% and the periodic cap is 2% what is the highest and lowest the rate could be?

A

3% lowest

7% highest

35
Q

What is the Life Cap on an ARM?

A

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.

36
Q

Life Cap Example:

An ARM has an interest rate of 5.5% with a 6% lifetime cap. What is the highest interest rate the ARM could have?

A

11.5% (5.5% + 6% = 11.5%)

37
Q

Life Cap Example:

An ARM has a start rate of 3% and the life cap is 6%, what is the maximum rate the ARM can reach over the life of the loan?

A

9% (3% + 6% = 9%)

38
Q

Some ARMS allow for a higher rate change at the first adjustment and then apply a periodic adjustment cap to future adjustments.

These ARMs are usually identified with ___ numbers?

A

3 numbers

Ex: 5/2/6

39
Q

ARM adjustment example:

5/2/6

What does each number represent?

A

5% at the first adjustment. The first number is the interest rate cap for the first adjustment

2% for subsequent adjustable periods. The second number is the period adjustment cap

6% total over the life of the loan. The third number is the lifetime interest rate cap

40
Q

Rate caps are more commonly shown as 2 numbers. For example, 2/6, what does each number represent?

A

2 - the first number indicates the maximum amount the interest rate can increase (or potentially decrease) from one adjustment period to the next

6 - the second number indicates the maximum amount the interest rate can increase during the life of the loan

41
Q

ARM Example: an ARM has a start rate of 4% with a 2/6 cap.

What is the highest rate this ARM can ever be?

A

10% (4% + 6% = 10%)

42
Q

What is a Rate Floor and who does it protect?

A

The rate floor is the lowest interest rate to which an ARM may adjust

A rate floor is sometimes included in a lending agreement in order to protect the lender.

43
Q

What are the 4 types of ARMs a lender may offer?

A
  1. Interest Only
  2. Payment Option
  3. Convertible
  4. Hybrid
44
Q

What is an Interest-Only ARM?

A

Allows payment of interest only for a specified number of years (typically between 3-10 years)

  • Allows the borrower to have smaller monthly payments for a period of time
  • After that, monthly payments increase even if interest rates stay the same, because the borrower must start repaying the principal and interest each month
45
Q

What is an Option ARM and what are the types of options offered?

A

A type of ARM that allows the borrower to choose among several payment options each month.

  • This provides flexibility for borrowers by allowing them to choose the payment that suits their current financial situation.
  • Option ARMs offer a variety of payment options, such as a minimum payment (which can lead to negative amortization), a 15 year or 30 year amortized payment, or an interest-only payment
46
Q

What is recasting?

A

Option ARM payments are typically adjusted every 5 years. The automatic payment adjustment is called recasting.

  • It amortizes the loan so it can be paid in full by the end of the loan term
  • Lenders do this by amortizing the higher principal balance created by the addition of interest (negative amortization)
47
Q

What makes an ARM a convertible ARM?

A

If the ARM has a conversion option. This allows a borrower to convert from an ARM to a fixed without going through the refinance process.

  • The lender may charge a one-time fee to convert
  • When the loan converts, it converts to the current prevailing rate
48
Q

What is a Hybrid ARM?

A

Combines the features of a fixed-rate loan with those of an adjustable-rate loan.

  • Desirable for borrowers who plan to sell their homes or pay off the loan within a few years
  • Fixed-rate feature gives the borrower some security with fixed rates in the initial term
  • Adjustable-rate feature is that the initial interest rate on these loans are typically lower than a fixed-rate loan
  • Initially, a fixed interest rate exists for a period of 3, 5, 7 or 10 years.
49
Q

Hybrid ARMs are often advertised as 3/1, 5/1, 7/1 or 10/1 ARMs. What does the first and second number tell a borrower?

A

The first number tells how long the fixed interest rate period will be

The second number tells how often the rate will adjust after the initial period.

50
Q

Hybrid ARM Example: 5/1

What does each number represent?

A

5 = 5 years at the initial fixed rate

1 = after the 5 years, the rate may adjust annually (1 year) until the loan is paid off

51
Q

Hybrid ARM Example: 2/28

What does each number represent?

A

The first number (2 years) is how long the fixed interest-rate period will be

The second number (28 years) is the number of years the rates on the loan will be adjustable

MLO Licensing (11 decks)

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