Products - Chapter 6 Flashcards
Closed-End Mortgage
Loans whose term and maturity date cannot change. Closed-end mortgages have an established time at which the entire debt will be repaid. This means when the loan closes and the repayment period begins, the borrower and the lender know exactly when the loan will be repaid if the payment schedule is followed.
Fixed Rate Mortgages
Fixed rate mortgages are mortgages in which the interest rate of the mortgage remains constant throughout the loan.
Adjustable Rate Mortgages
A loan in which the interest rate can change over the term of the loan. Since the rate can change, ARMs are sometimes referred to as variable rate mortgages because their most obvious feature is the variance of rate.
Most ARMs function on a 30-year full amortization schedule.
Traditional ARMs
Loans in which the rate adjusts on a periodic basis. Most traditional ARMs have an interest rate that adjusts each year, but at one time in history it was not unusual for the rate to change monthly.
Hybrid ARMs
The most common adjustable rate mortgages available in the market today. The hybrid ARM combines features of a fixed rate mortgage and an adjustable rate mortgage. An example of a hybrid ARM is the 5/1. With a 5/1 ARM, in the first five years the loan’s interest rate remains fixed at the note (initial) rate. After the fifth year, the rate adjusts once annually. Common forms of hybrid ARMS include 3/1, 5/1, 7/1, and 10/1 (three, five, seven and ten-year set periods respectively).
Option ARMs
The borrower has the option of three different payment amounts. One option allows for the borrower to make a fully amortized payment like any other ARM loan. The second option allows the borrower to make a flat payment amount that is only partially amortizing (the borrower does not make a full payment). This flat payment could result in negative amortization. A third option allows the borrower to make an interest-only payment in which only the monthly interest is paid.
With option ARMs, the interest-only and flat payment choices are only available for a limited period (usually the first 5 years of the loan term). After this period, the borrower is required to make a fully amortizing payment.
How An ARM Adjusts
The factors that impact an ARM’s interest rate are the margin and the index
Margin
The lender’s profit on the loan and an amount of interest that remains constant. Since the margin serves as the lender’s cut of the mortgage payment, the interest rate of an ARM can never go below the margin - regardless of market factors.
Index
Makes the ARM’s rate change. It is an instrument that tracks the financial marketplace. If the market moves, so will the rate of the ARM. In today’s market the most commonly used indices are the London Interbank Offered Rate (LIBOR), United States Treasury Bill (T-Bill) and the Cost of Funds Index (COFI a.k.a The 11th District). The index that will be used to determine an ARM loan’s adjustment is included in the language of the mortgage contract and cannot be changed once the loan closes.
Note Rate
(AKA initial rate) is the interest rate at the time of loan closing. The reason it is known as the note rate is because the initial rate is the one listed on the promissory note.
Fully Indexed Rate
A combination of the margin plus the index. It is the interest rate of a mortgage provided there are no limits on how high or low the rate may go.
Fully Indexed Rate Calculation
Margin + Index = Fully Indexed Rate
So if a lender’s profit margin was 2.5% and the current index was 3%, the fully indexed rate would be 5.5% (2.5% + 3% = 5.5%).
CAPS
Caps are voluntary limits set by the lender when making the mortgage agreement, and if included, they are written as part of the mortgage contract.
Think of the cap as a ceiling or a floor that the ARM’s rate cannot exceed. If the fully indexed rate remains within the cap, then that’s the new rate. But if the fully indexed rate
exceeds the cap, the ARM’s new rate stops at the cap.
Most common CAPS
Initial - first year rate cap
Annual (also known as periodic cap) - 2nd year and beyond cap per year
Lifetime - Over the life of the loan the rate may never change by more than _% from initial rate.
Balloon Mortgages
Loans that require a planned full repayment of the balance prior to the end
of a 30-year amortization schedule