Karen has chosen to accept an Adjustable Rate Mortgage. She qualified at a fully
ID: 2691824 • Letter: K
Question
Karen has chosen to accept an Adjustable Rate Mortgage. She qualified at a fully indexed rate of 7.5%, but is offered 6.0% as a discounted interest rate for the first three years of her loan. Her 3/1 ARM will be based on the LIBOR index which stands at 4.5% today. The interest rate caps for her loan are 2/1/6. 1.) What percentage is the lender's margin for this loan? 2.) She has a 3/1 ARM. What does the "1" mean? 3.) What is the maximum interest rate Karen will ever have to pay on this loan? 4.) Unless Karen sells the house or refinances, how long will she be paying on this loan? 5.) When Karen's ARM interest rate adjusts, the rate she will pay is her current ARM rate plus the appropriate cap or the lender's margin plus the new index rate, whichever is __________. 6.) In year seven, Karen's ARM rate is about to adjust. Her current ARM rate has been 7.75%, but the index rate is now 5.25%. Taking into account the annual interest rate cap and the margin for her loan, what will Karen's new interest rate be?Explanation / Answer
The most common adjustable rate mortgage is called a “hybrid ARM,” in which a specific interest rate is guaranteed to remain fixed for a specific period of time. Often, this initial rate is lower than what you could otherwise get in a traditional 30-year fixed loan.
For example, a 3/1 ARM or a 5/1 ARM will offer a fixed interest rate for three or five years, respectively. However, the fixed period can vary greatly, from one month up to ten years, and it’s only limited by what the lender will allow. Generally, the shorter the fixed period, the lower the interest rate will be during that time.
For the many people who refinance their mortgage or move every few years, an ARM can be an effective way to pay less in interest than would be possible with a standard 30-year fixed loan. Moreover, this fixed period can give you time to assess what direction interest rates are heading, and decide when or if to refinance. That said, most people choose to refinance at or near the end of the fixed rate period.
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