(Newswire.net — May 18, 2018) — When you buy a house, you’ll probably not have the entire purchase price in cash and will need to obtain financing from a bank or other lender. Loans for the purchase of real estate, usually referred to as mortgages, come in a few different forms. One common flavor of mortgage is the adjustable-rate mortgage (ARM). In general, an ARM has an interest rate that can fluctuate over the life of the loan. However, there is a limit on how high your interest rate can go on your ARM. The purpose of this article is to break down the lifetime cap on an ARM, but you should contact the lawyers at Adam Leitman Bailey, P.C. if you have any lingering questions about this, or any other, aspect of your mortgage.
Lifetime Cap Basics
As the name suggests, a lifetime cap represents the highest interest rate a borrower can be required to pay during the life of their loan. Typically, the cap is defined as a percentage amount above base interest rate. For example, if your initial interest rate is 5%, and your lifetime cap is 5%, this actually means that your interest rate can fluctuate up to 5% beyond your initial rate, for a maximum interest rate of 10%. Knowing your lifetime cap is critical, as it can be used to proactively calculate your monthly mortgage payment should your interest reach the cap rate.
Another obvious benefit of a lifetime cap is the fact that it protects the borrower from drastic and unpredictable interest rate hikes during the life of the loan. Because you know the cap, and can use it to calculate maximum mortgage payments ahead of time, you know exactly what you’re getting into and can’t be caught off guard by a steep hike.
Keep in mind that other types of mortgages have similar mechanisms, but these function differently than the lifetime cap in an ARM. For example, an interest rate ceiling does define a maximum permitted interest rate, but it does so in absolute terms (“interest rate is not to exceed 10%”), whereas the lifetime cap in an ARM is a percentage increase permitted above an initial, fixed interest rate. The difference is subtle, but important.
Financial Planning Around a Lifetime Cap
Because a lifetime cap provides a strict limit on the maximum interest rate allowed under an ARM, it allows borrowers to understand the maximum payment obligations possible over the life of their mortgage. Knowing this ahead of time allows buyers to make smart decisions about whether they can afford a mortgage under the most expensive conditions, or whether it would be too big of a risk. Understanding the lifetime cap can also help buyers to make strategic borrowing decisions, such as taking an ARM for the initially lower fixed interest rate, but then later refinancing to a fixed rate mortgage with an interest rate that is lower than the ARM’s lifetime cap. These types of strategic decisions should be made with the advice and assistance of your lawyer.