Home Loans
Adjustable Rate Mortgage: Protect Yourself with Rate and Payment Caps
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By Louie Latour
Interest rate and payment caps can protect you from a mortgage nightmare, if you structure them properly. Nearly every Adjustable Rate Mortgage (ARM) features caps to protect the borrower. These caps are an essential part of any variable rate mortgage because they protect you from runaway payment amounts, no matter how interest rates rise. Here is what you need to know about caps if you are considering an Adjustable Rate Mortgage.
When you read about caps you will find they come in several varieties: periodic, initial, and lifetime caps. Initial caps protect the borrower during the first adjustment only. After the first adjustment the periodic cap will limit how much your payment amount or interest rate can be adjusted each time after the first adjustment. Finally, the lifetime cap limits how much the interest rate can change over the life of the mortgage.
Not all Adjustable Rate Mortgages have initial caps that differ from the periodic rate cap. You need to read the fine print carefully to understand how your caps are structured. All of the information pertaining to caps will be documented in the loan contract. It is important to ensure that your mortgage includes both interest rate and payment amount caps. If these caps are not structured correctly you could wind up with a payment amount that does not include all of the interest due in any given month. If this happens, the lender will simply add the unpaid interest to the mortgage balance, a concept called negative amortization. Needless to say, negative amortization is a bad thing that you want to avoid.
You can learn more about your mortgage options, including costly mistakes to avoid by registering for a free mortgage guidebook.
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