Consumer Handbook on Adjustable Rate Mortgages

In general, the rate on your loan can go up at any scheduled uled adjustment date when the index plus the margin is higher than the rate you are paying before that adjustment. The next example shows how a 5% overall rate cap would affect your loan.

Let's say that the index rate increases 1% in each of the first irst ten years. With a 5% overall cap, your payment would never exceed $813.00--compared to the $1,008.64 that it would have reached i the tenth year based on a 19% indexed rate.

Payment Caps

Some ARMs include payment caps, which limit your monthly nthly payment increase at the time of each adjustment, usually to a percentage of the previous payment. In other words, with a 7% payment cap, a payment of $100 could increase to no more than $107. 50 in the first adjustment period, and to no more than $115.56 in the second. Let's assume that your rate changes in the first year by 2 by 2 percentage points, but your payments can increase by no more than 7% in any one year. Here's what your payments would look like:

Many ARMs with payment caps do not have periodic interest rate rate caps. Negative Amortization

If your ARM contains a payment cap, be sure to find out about " bout "negative amortization." Negative amortization means the mortgage balance is increasing. This occurs whenever your monthly mortgage payments are not large enough to pay all of the interest due on your mortgage. Because payment caps limit only the amount of payment increases, ses, and not interest-rate increases, payments sometimes do not cover all of the interest due on your loan. This means that the interest shortage in your payment is automatically added to your debt, and interest may be charged on that amount. You might therefore owe th lender more later in the loan term than you did at the start. However, an increase in the value of your home may make up for the increase in what you owe.

The next illustration uses the figures from the preceding ding example to show how negative amortization works during one year. Your first 12 payments of $570.42, based on a 10% interest rate, paid the balance down to $64,638.72 at the end of the first year. The rate goes up to 12% in the second year. But because of the 7% payment cap, payments are not high enough to cover all the interest. The interest shortage is added to your debt (with interest on it), which produces negative amortization of $420.90 during the second year.