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Unformatted text preview: nterest rate = 10% Monthly payment = $570.42 Second lender One–year index = 8% Margin = 3% ARM interest rate = 11% Monthly payment = $619.01 Example: Rate Cap
At a time when market interest rates might be at 6.5 percent, initial teaser rates could be offered at 4.5 percent, instead of at the then fully–indexed 6.5% rate. The lifetime cap of 5% usually applies to the fully–indexed 6.5% rate, not the 4.5% teaser rate, producing an 11.5% maximum rate for the life of the loan. DISCOUNTS
Some lenders offer initial ARM rates that are lower than the sum of the index and the margin. Such below–market rates, called discounted rates, are often combined with large initial loan fees (“points”) and with higher interest rates after the discount expires. Dynasty School (www.dynastySchool.com) 9-11 REAL ESTATE FINANCE
Risk – All ARMs are to some extent a gamble on the future movement of interest rates, but the risk is compounded by the use of discounts. The borrower must decide in each particular situation if the initial advantage is worth the risk. Seller Buydown – Very large discounts are often arranged by the seller. The seller pays an amount to the lender so the lender can offer a lower rate and lower payments early in the mortgage term. This arrangement is referred to as a “seller buydown.” The seller may increase the sales price of the home to cover the cost of the buydown. Other buydown – Borrowers may also be able to negotiate buydowns of the terms of ARMs. Qualifying – A lender may use a low initial rate to decide whether to approve a loan, based on the borrower's ability to make payments. Borrowers must seriously consider whether they will be able to afford payments in later years when the discount expires and the rate is adjusted. Future Payment Shock – With a discounted ARM, the low initial payment will probably not remain low for long, and any saving during the discounted period will normally be made up during the life of the mortgage or be included in the price of the house. “Payment shock” may occur if the mortgage payment rises sharply at the first adjustment. Example: Discounts
Here is how a discount might work. Let's assume the one–year ARM rate (index rate plus margi...
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