This preview shows page 1. Sign up to view the full content.
Unformatted text preview: actors, Insurance, Real Estate, Notary, Nurse, Food Handlers, Tax and Securities 9: FIXED RATE MORTGAGE AND ALTERNATIVE MORTGAGE INSTRUMENTS Dynasty School (www.dynastySchool.com) 9-21 REAL ESTATE FINANCE HOW CAN THE BORROWER REDUCE THE RISK?
Choosing an ARM solely because of its low initial rate can be risky. Borrowers can look for mortgages with features designed to reduce such risks. Many ARMs have “caps” that protect borrowers from extreme increases in interest rates or monthly payments. Others allow borrowers to convert an ARM to a fixed–rate mortgage. However, these features may cost more or add risks of their own, such as negative amortization. Interest–Rate Caps – An interest–rate cap places a limit on the amount the interest rate can increase. A cap is like insurance, so ARMs with caps may cost more than ARMs without them. Interest caps are of two types: periodic caps limit the interest–rate increase from one adjustment period to the next; overall caps limit the interest–rate increase over the life of the loan. An ARM may have both a periodic and an overall interest–rate cap. Example: Periodic Cap
Consider an ARM with a periodic interest–rate cap of 2%. At the first adjustment, the index rate goes up 3%. The example shows what happens. ARM Interest Rate First year at 10% 2nd year at 13% (without cap) 2nd year at 12% (with cap) Monthly Payment $570.42 $717.12 $667.30 Difference in second year between payment with the cap and payment without the cap = $49.82 Deferred Increase – A drop in interest rates does not always lead to a drop in monthly payments. In fact, with some ARMs that have interest rate caps, the payment amount may increase at a given adjustment period even though the index rate has stayed the same or declined. This may happen after an interest rate cap has been holding the interest rate down below the sum of the index plus margin. Example: Increase Deferred by Periodic Cap
9-22 Licensing School for Appraisal, CPA, Contractors, Insurance, Real Estate, Notary, Nurse, Food Handlers, Tax and Securities 9: FIXED RATE MORTGAGE AND ALTERNATIVE MORT...
View Full Document
This note was uploaded on 12/30/2010 for the course SOC 101 taught by Professor Zhung during the Spring '10 term at Punjab Engineering College.
- Spring '10