Adjustable rate mortgages can be tricky beasts with a language of their own, so learn your cap, index and reset terms. Here are 10 of the most important terms.
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10 must-know ARM, reset terms |
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1. Cap. The top limit on the amount the interest rate can increase during a certain period of an adjustable-rate mortgage, or ARM. Every ARM has two caps: a periodic cap, which limits the periodic changes to the interest allowed in the loan agreement, and a lifetime cap, which governs the total increase that can be imposed during the life of the loan.
2. Cap -- lifetime. The lifetime cap is the highest possible interest rate that a particular adjustable-rate mortgage, or ARM, can have. Many ARMs have a lifetime cap of 6 percentage points above the introductory rate. That means, for example, that if the ARM's introductory rate was 5 percent, the maximum possible rate would be 11 percent. Although the most common lifetime cap is 6 percentage points above the introductory rate, some loans have caps that are greater or less than that.
3. Cap -- periodic. The periodic cap is the limit on the amount that the interest rate can increase or decrease when the adjustment is made on an adjustable-rate mortgage, or ARM. Many ARMs have a periodic cap that prevents the interest rate from rising or falling more than 2 percentage points in one year. There are exceptions: On many ARMs that have an introductory rate lasting three or more years, the first rate adjustment is more than 2 percentage points.
4. Index. A table of yields or interest rates being paid on debt (such as Treasury notes or bank deposits) that is used to determine interest-rate changes for adjustable-rate mortgages and other variable rate loans such as credit card debt. Some of the most common indices are: the one-year Treasury Constant Maturity Yield; the Federal Home Loan Bank (FHLB) 11th District Cost of Funds; prime rate as listed in the Wall Street Journal.
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