Consumer safeguards limiting the amount monthly payments on an adjustable rate mortgage may change during the life on the mortgage. CAPS are usually only seen on Adjustable Rate Mortgages (ARMs)
A CAP is a restriction put on adjustments that will change the interest rate or payments, such as the annual cap on an adjustable rate loan (ARM) or the cap on a rate over the life of the loan.
Loans such as the Pay Option ARM loans usually have LTV (Loan to Value) CAPS also. Because these types of loans can incur negative amortization (where your loan balance goes up instead of down), usually the lenders will place Loan to Value restrictions (CAPS) on how high your loan balance can increase before they no longer allow the negative amortization to continue to occur. Many lenders will cap the loan balance from ever going higher than 110% of your homes value.
Caps can apply to both the interest rate and the monthly payment amount. On the popular Option ARM loans, the payments normally have a yearly cap of 7.5% for the first five years. That means the payment can adjust no more than 7.5% of the previous year's payment.
Caps are a very important protection for the consumer and need to be considered when looking at ARM loan programs.
In some cases the caps
apply to the increase OR the decrease of the interest rate. There is also a Floor rate
associated with Adjustable Rate programs. A Floor rate is the lowest the rate is allowed to adjust and is usually equal to the Margin.
Consult with your mortgage professional to find out what types of CAPS your adjustable rate mortgage is going to have. A 1% or 2% Cap is a very common annual cap placed on adjustable rate mortgages and a 5% or 6% cap are very common lifetime (life of the loan) caps placed on adjustable rate mortgages. These caps mean that the rates can not adjust up or down any more than these percentage increments at their given adjustment periods.
You can see how the caps will effect the payment on the truth in lending. Keep in mind that the changes are calculate at today’s rates and are subject to change in the future.
Common CAP's for your ARM would be 2/2/6 which your mortgage will adjust up to 2% for the first adjustment, up to 2% for each adjustment afterwards & a maximum of 6% over the life of the loan.
The 2/2/6 CAP's are most common on 5/1, 7/1 & 10/1 ARM's.
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Information listed above is to be used for educational purposes only and is not guaranteed