CAPS

LIFE CAPS:
Because ARM loans are tied to the economy, they can be subjected to significant interest rate changes over the life of the loan. For this reason, The Truth in Lending Law requires that all adjustable rate mortgages have "life caps". A life cap is the maximum rate of interest that can be charged for a particular ARM loan. Every ARM loan must have a life cap which is determined when the loan is made. A life cap can be expressed in terms of a maximum amount of charge from the initial interest rate, such as 6.00% above the initial interest rate. In this instance, using our earlier example, the maximum rate would be 12.13% (6.00% added to the initial interest rate of 6.13%).

ADJUSTMENT CAPS:
In addition to life caps, some ARM loans may have another type of cap, known as an "adjustment cap". This cap is a limit on the amount the interest rate can change at any one time. The frequency with which adjustments can occur will be determined when the loan is made. A common adjustment cap is 2.00%, although a different percentage amount may be used. Using our example of 6.13%, if the maximum amount the interest rate could change at the first adjustment is 2.00%, then the interest rate could go no higher than 8.13%, or no lower than 4.13%, even if the index were to change by more than 2.00%. The idea behind adjustments to caps is to minimize the financial impact of adjustments to a loan.

PAYMENT CAPS
There are other ARM loans which are capped in a different way. These have "payment caps" in addition to the life cap. This is a limit on the amount that a payment may change at each adjustment. This type of cap is often expressed in terms of a percentage that the amount of a payment may change, such as 5.00%, the most it could increase would be by $50.00. At the next adjustment, the most it could increase would be $52.50 (5.00% of $1,050.00). If your ARM contains a payment cap, be sure to ask about the possibility of "negative amortization". This occurs whenever your monthly mortgage payment is not large enough to pay all of the interest accruing faster than the payment can pay it off, this interest is added back to the principal, causing you to actually owe more at the end of the loan.

DISCLOSURE

As you can see, there are advantages and disadvantages to ARM loans. One of the advantages is that ARM loans are generally offered at lower initial interest rates than fixed-rate loans. Another advantage is the potential for the interest rate to decline over the life of the loan, saving you money. One disadvantage, however, is that the rate may increase over the life of the loan, which would mean that you would end up paying more.

While ARM loans can be fairly complex, federal law requires that you receive a detailed disclosure for any ARM loan program in which you express interest before you make any decisions. This disclosure will list how the loan may adjust over the course of its term. It will allow you to see worst case scenarios of what could happen to your loan payments. Along with the disclosure, you will receive further information which will explain ARM loans in much greater detail. Your loan officer will consult with you and help you to understand all of the different facts and figures and what they represent as a part of the loan. This will help to guide you in your decision process.

The final decision is yours. Be sure to weigh the benefits against the risk and don't be afraid to ask questions. You may decide that an ARM loan is right for you.

Buying a home is one of the most significant investments you will make in your lifetime; but obtaining a mortgage loan can be a very complicated process. It is important for you to understand all of the costs and information being presented to you when you are shopping for a mortgage loan.

WHERE DOES AN "APR" COME FROM?

The Truth in Lending Act is a federal law that requires creditors to provide information to consumers about the terms and costs of a loan. The intent is to help consumers better understand loan transactions, and to assist them in comparing loans offered by different lenders. The law is administrated under a Federal Reserve Board regulation known as Regulation Z.

One of the required disclosures that lenders must make in a mortgage loan transaction, is something commonly referred to as the APR.

WHAT IS AN "APR" AND WHAT DOES IT REPRESENT?

APR is an acronym for "Annual Percentage Rate". This term was specially designed to help consumers understand the relative cost of a transaction, and to guide them in their search for the best loan.

HOW IS AN "APR" DETERMINED?

The concept of the annual percentage rate can be difficult to understand because it is based on a complex mathematical formula, which is prescribed in Regulation Z. What is important to understand though, is that the APR is a measure of the cost of credit expressed as a yearly rate.

The APR reflects the amount being financed, the interest rate, the timing of the payments, and other costs (prepaid charges) required as a condition of the mortgage loan which makes up the finance charge. The finance charge, another required disclosure under The Truth in Lending Act, expresses as a dollar amount the costs associated with the loan, including interest and charges payable by the borrower such as points, loan fees, origination fees, application fees, and insurance, to name a few.

WHAT IS AN EXAMPLE OF AN "APR"?

When the various components mentioned above are factored together using the APR formula, the APR can be calculated. Because the APR takes into consideration the various fees that are required as a part of the loan, the APR is often higher than the actual rate of interest for the loan.

For example:

Type of loan = Fixed rate
Initial Interest Rate = 8.000%
Loan Term = 30 years
Amount of Loan = $ 90,000.00
Total Prepaid Charges = $ 2,673.27
APR = 8.5273%

WHAT IS THE DIFFERENCE BETWEEN THE INTEREST RATE AND THE "APR"?

Keep in mind that the APR is an artificial measurement of the relative cost of the loan transaction. It doesn't have a bearing on the actual rate of interest on a particular loan, but it does take the rate of interest into account. Your loan officer can calculate the APR of various loan programs for you and can explain why these differences between interest rates and APRs occur.

Because the APR expresses the overall cost of the loan as a percentage, comparing the APR of a particular mortgage loan with a similar loan is one way to measure the relative cost of the loans. This isn't the only factor to consider when getting a mortgage loan, but it can be very useful in helping you decide.

Be sure to take into account all of the other information that is provided to you by your loan officer including the interest rate and any fees or charges that you may have had to pay.

Just because an APR is lower on one loan than on another, it doesn't necessarily mean that particular mortgage loan is the best for you.

Your loan officer, will help you to understand all of the costs associated with obtaining your mortgage loan and guide you on your way to purchasing your home.

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