ARM Caps

Adjustable rate mortgages (ARMs) may seem like a good idea until you consider that your interest rates and payments are likely to rise in the future. However, because of interest rate and payment caps, this disadvantage to ARMs can be minimized. Caps allow ARMs to be an attractive option by ensuring that interest rates on your loan will stay low enough for you to handle.

The first type of cap employed by lenders is a periodic cap. Periodic caps place limits on the amount interest rates can increase from one period to the next. Periodic caps are common, but are not always included with ARMs.

Another type of cap associated with ARMs is the overall cap. Overall caps place limits on the amount interest rates can increase over the loan’s entire lifetime. Unlike periodic caps, overall caps are required by law. While periodic caps are a good protection against sudden changes in insurance rates, overall caps are useful to protect against rates rising to a higher level than expected by either the lender or the consumer.

Payment caps are also available with some ARMs. These caps limit the amount your payments can increase at each adjustment, rather than limiting the amount your interest rates can increase from period to period. ARMs with payment caps generally do not also carry periodic caps.

The final cap-related ARM issue is carryovers. When a cap holds down your interest rate to a level lower than the rise in the index, the difference between the index increase and your interest rate can be carried over and applied at the next adjustment. For example, if you have a periodic cap of one percent, and the index rises one and a half percent, the remaining half percent can be carried over and added at the next adjustment