Chapter 5: Adjustable and Floating Rate Mortgage Loans

Practice flashcards covering definitions, loan mechanics, and risk relationships for adjustable and floating rate mortgage loans based on Chapter 5.

Adjustable Rate Mortgages (ARM’s)

Mortgage loans with interest rates that are tied to a market rate, or index, and may change with market conditions.

Price Level Adjusted Mortgage (PLAM)

An A4RM where the loan balance would be adjusted up or down by a price index.

Index

The interest rate series agreed on by both the borrower and the lender and over which the lender has no control.

Margin (Spread)

A premium in addition to the index chosen.

Composite Rate

The sum of the interest rate based on the index chosen plus the margin used to establish the new rate of interest on each reset date.

Reset Date

The point in time when payments will be adjusted.

Negative Amortization

When additions to the outstanding loan balance are allowed in the loan agreement.

Caps

Maximum increases allowed in payments, interest rates, maturity extensions, and negative amortization on reset dates.

Floors

Maximum reductions in payments or interest rates.

Assumability

The ability of the borrower to allow a subsequent purchaser to assume a loan under the existing terms.

Discount Points

Amounts that increase the lender’s yield.

Prepayment Privilege

An option to prepay without penalty.

Lockouts

Provisions that prohibit prepayment for a specified number of years, typically found on commercial mortgage loans.

Conversion Option

The right of an ARM borrower to convert to a FRM.

Hybrid Loans

Loan variations such as 3/1, 5/1, and 7/1.

Interest-Only ARM Monthly Payment Calculation

$$\text{Monthly payment} = \text{loan amount} \times (\text{interest rate} \div 12)$$

ARM expected yield relationship

At origination, the expected yield on an ARM should be less than the expected yield on an FRM.

Interest Rate Risk and Index Term

Adjustable rate mortgages tied to short-term indexes are generally riskier to borrowers than ARM’s tied to long-term indexes.

Adjustment Interval Risk

ARM’s with shorter time intervals between adjustments in payments are generally riskier to borrowers than those with longer time periods.

ARM I

An ARM with no caps or limitations.

ARM II

An ARM with payment caps and negative amortization.

ARM III

An ARM with interest rate caps.