The Floor Rate Matters
Many borrowers overlook the impact of having a minimum or floor interest rate on their adjustable rate mortgage. Some may wrongly think that because they have an adjustable rate loan their interest rate can go up and down without constraints.
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The floor rate is the lowest interest rate that the mortgage can go to. If the loan is adjusting and the interest rate index plus the margin is less than the floor rate then the borrower will be charged the floor rate instead. In this example, we illustrate a mortgage where the floor (minimum) interest rate is equal to the starting interest rate on the loan. This has been a common situation for subprime mortgages. The interest rate is fixed for the first three years. Let's examine, a very unlikely scenario, the best case scenario where the index rate goes to zero in the 2nd month and stays at zero for the duration of the mortgage. If there was no floor rate, the borrower would have been charged the 4.5% margin beginning in the first adjustment period. When you see the amortization schedule for this example you'll see that in best case scenario this borrower will be charged 7.5% throughout the life of the loan.
Click on the Calculate button below to generate the amortization schedule for this example or enter your own information or explore the other examples.
The Basics: The Floor Rate Matters Margin Makes a Difference Payment Shock
Interest Rate Caps are Important Comparing Future Interest Rate Scenarios
Common Loan Types: 1/1 ARM 3/1 ARM 5/1 ARM 7/1 ARM 10/1 ARM
Other Examples: 2/28 3/27 5/25
