Interest Rate Caps are Important
Many borrowers overlook the importance of their interest rate caps. The interest rate caps are the maximum amount that the interest rate can change during the specified adjustment period. For hybrid loans whose rate is fixed for a number of months, the cap on the first adjustment is typically larger than the cap on subsequent adjustments.
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In this example, the interest rate is fixed at 7.5% for two years. To illustrate the importance of the interest rate caps we'll examine the worst case scenario where in the 2nd month the index rate increases to the maximum interest rate for the loan and stays there for the duration of the mortgage. When you generate the amortization schedule you'll see that at the beginning of the third year the interest rate will jump to the first adjustment maximum rate of 9.5% since the index rate plus the margin would be 18% which exceeds the starting interest rate of 7.5% plus the maximum increase of 2% allowed on the first adjustment. The rate will continue to increase 1%, the maximum for adjustments after the first one, every 6 months until it reaches the maximum rate allowed on the loan in the 49th month.
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
