There’s many terms surrounding an Option Adjustable Mortgage which can sometimes leave people confused, so we have done a glossary of terms to help clear any misconception.
Freedom Point:
The moment in time when a homeowner’s assets exceed their debts and when paying off their mortgage becomes a strategic financial planning decision. Traditionally, this was accomplished when homeowners paid off their home—that magic moment of owning their home free and clear (debt free).
Fully Indexed or Effective Rate:
This interest rate is the sum of the current index rate on an ARM plus the margin.
Index:
An indicator that is typically measured by an average of an economic variable over a certain period of time.
Lifetime Cap:
The amount that the interest rate is allowed to increase during the term of the mortgage.
Margin:
The amount added to the index on an ARM to determine the interest rate at each adjustment. Generally, the index remains fixed over the life of the loan.
Maturity:
The period of time over which the loan balance must be paid in full.
Maximum Loan Balance:
The maximum amount that the lender will allow the loan amount to increase to. The maximum loan balance is typically a percentage of the original loan amount.
Negative Amortization:
The opposite of “Amortization”, which means that monthly payments are large enough to pay the interest and reduce the principal on the mortgage. Negative amortization occurs when the monthly payments do not cover all of the interest cost. When negative amortization occurs, the interest cost that is not covered is added to the unpaid principal balance. This means that even after making many payments, the borrower could end up owing more than he or she did at the beginning of the loan. Negative amortization can occur when an ARM has a payment cap that results in monthly payments that are not high enough to cover the interest that is due.
Pay Rate:
The interest rate used to calculate the mortgage payment. The pay rate and the interest rate may not be the same.
Payment Cap:
The limitation on increases or decreases in the payment amount of an adjustable-rate mortgage. The payment cap is usually 7.5% annually.
Recast Point:
The date when a homeowner with an Option ARM has their minimum monthly payment significantly increased higher because their principle balance increases to more than 110% of the original amount borrowed. It is highly recommended that Option ARM homeowners save money monthly in a Freedom Account so that the Recast Point doesn’t increase the time it will take them to achieve their Freedom Point. Many times a recast can cause the client’s payment to increase by as much as 80% to 120%. Obviously, if homeowners aren’t able to increase their savings rate and increase their investment assets, this type of payment shock can be devastating to a homeowner.
Start Rate:
Often called the “teaser rate” it’s the initial interest rate charged on the loan. This rate typically lasts from one to three months.
Stop Period:
Typically, the period in which the lender will no longer allow a payment other than the fully amortized payment.
Term:
The period that is used to calculate the monthly mortgage payment. The term is usually the same as the maturity.
So there you have it, all the frequent terms encountered when dealing with Adjustable Rate Mortgages so hopefully our glossary will help shed some light on what everything means and make it easier for you when dealing with your ARM paperwork.
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