Definition
An Interval Adjustment Cap is a provision within an adjustable-rate mortgage (ARM) agreement that sets a ceiling on how much the interest rate can increase or decrease during each adjustment period. Typically, ARMs have a fixed interest rate for an initial period, followed by periodic adjustments based on an index plus a margin. The Interval Adjustment Cap ensures that these periodic rate changes aren’t excessively volatile, thereby providing some predictability for the borrower’s monthly payments.
Key Characteristics:
- Adjustability: Pertains to ARMs where interest rates are periodically adjusted.
- Periodic Limits: Caps are applied during each adjustment interval.
- Provides Predictability: Helps manage potential payment fluctuations.
Examples
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Example 1: Jane has a 5/1 ARM with an initial fixed-rate period of 5 years. After this period, her interest rate can adjust each year. Her loan specifies an Interval Adjustment Cap of 2%, meaning at each adjustment interval (annually, in this case), the interest rate cannot increase or decrease by more than 2%.
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Example 2: Tom’s ARM includes a 1% Interval Adjustment Cap. Initially fixed for 3 years, the rate will then adjust every 6 months. Due to the cap, the interest rate cannot change by more than 1% per adjustment period.
Frequently Asked Questions
Q1: What is the difference between an Interval Adjustment Cap and a Lifetime Cap?
The Interval Adjustment Cap restricts rate changes within each specified adjustment period, while a Lifetime Cap places a ceiling on how much the rate can increase over the entire loan term.
Q2: Can the Interval Adjustment Cap apply to a rate decrease as well?
Yes, Interval Adjustment Caps can limit both rate increases and decreases, ensuring rate fluctuations aren’t too extreme.
Q3: How does an Interval Adjustment Cap benefit borrowers?
It provides a level of predictability and stability in mortgage payments, protecting borrowers from drastic interest rate changes over short periods.
Q4: Are Interval Adjustment Caps standard in all ARM agreements?
Most ARM agreements include some form of interval adjustment limitation, but specific terms can vary widely depending on the lender and the loan agreement.
Q5: How often can rate adjustments occur with an ARM?
This depends on the loan terms, but common intervals include annually (1-year ARM), biannually (6-month ARM), or at custom periods specified in the mortgage agreement.
Related Terms
1. Adjustable-Rate Mortgage (ARM): A mortgage with an interest rate that adjusts periodically based on an index.
2. Initial Cap: The limit on the rate increase when the adjustable period begins after the initial fixed-rate phase.
3. Lifetime Cap: The maximum interest rate increase allowed over the entire term of the ARM.
4. Margin: The set percentage added to the index to determine the adjustable interest rate for the ARM.
5. Index: A benchmark interest rate that reflects general market conditions, used to calculate ARM rates.
Online Resources
- Investopedia - Adjustable-Rate Mortgage (ARM)
- Consumer Financial Protection Bureau (CFPB) - Adjustable Rate Mortgages
- Federal Reserve - Mortgage Choice Guide
References
- “Mortgage Markets and Institutions” by Julie Stackhouse
- “Investing in Mortgage-Backed and Asset-Backed Securities” by Glenn M. Schultz
Suggested Books for Further Studies
- “The Mortgage Professional’s Handbook” by David Reed: A comprehensive resource on various mortgage products, including ARMs.
- “Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques” by Frank J. Fabozzi: Detailed discussion on mortgage-backed securities, which typically includes ARM pools.
- “Fixed Due vs. Adjustable Rate Mortgages: Which is Better?” by Lawrence Peterson: A comparative analysis helpful for understanding the practical implications of ARM features.
