Consumer Handbook on Adjustable Rate Mortgages

As the example shows, even if the index rate stays the same, ame, your monthly payment would go up from $476.95 to $568.82 in the second year. Suppose that the index rate increases 2% in one year and the ARM ARM rate rises to a level of 12%.

That's an increase of almost $200 in your monthly payment. You You can see what might happen if you choose an ARM impulsively because of a low initial rate. You can protect yourself from increases this big by looking for a mortgage with features, described next, which may reduce this risk.

HOW CAN I REDUCE MY RISK?

Besides an overall rate ceiling, most ARMs also have "caps" that that protect borrowers from extreme increases in monthly payments. Others allow borrowers to convert an ARM to a fixed-rate mortgage. While these may offer real benefits, they may also cost more, or add special features, such as negative amortization.

Interest-Rate Caps

An interest-rate cap places a limit on the amount your your interest rate can increase. Interest caps come in two versions:

* Periodic caps, which limit the interest rate increase from o one adjustment period to the next; and

* Overall caps, which limit the interest-rate increase over the life of the loan. n. By law, virtually all ARMs must have an overall cap. Many have have a periodic interest rate cap. Let's suppose you have an ARM with a periodic interest rate cap cap of 2%. At the first adjustment, the index rate goes up 3%. The example shows what happens.

A drop in interest rates does not always lead to a drop in p in monthly payments. In fact, with some ARMs that have interest rate caps, your payment amount may increase even though the index rate has stayed the same or declined. This may happen after an interes rate cap has been holding your interest rate down below the sum of the index plus margin.

Look below at the example where there was a periodic cap of 2% f 2% on the ARM, and the index went up 3% at the first adjustment. If the index stays the same in the third year, your rate would go up t 13%.