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7/1 Arm Structure

My lender is quoting the following to me as a 7/1 ARM option
- Initial Rate : 3.25% (Index : 2.25% + Margin : 0.5%)
- He says the rate will be FLAT for 7 years given the 7/1 ARM Structure
- After which the rate could change every year and go up by 2% (Cap) but cannot cross 2% for the next 5 years ( Year 8- 12) 
 (i.e. Worst case the rate will be 4.25%= 2.25% base + 2% cap  during year 8 - 12 )
- After year 13 - it can go up / down but there is a MAX of 8.25% (5% above the index) 

Question : Can there be a 7/1 ARM - with such structure that protects you in year 8 - 12 from rates to cross more than 4.25% ??

I tried reading a lot but could not find this info on ARM and want to understand if there is some more validation or cross checking that  I need to do. Is this a common practice ?


 
  • June 15 2014 - US
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Answers (4)

I concur with virtually all of the technical information provided.  Particularly, you should double check that margin. If it is, in fact, .5% you shouled grab it immediatelty :).  In a larger sense it's important to understand why what you are seeking is probably not available.  ARMs are about risk vs. reward.  On a fixed rate loan the lender is taking all the risk.  If rates go down, you can always refinance to a lower rate.  But if rates go up, the lender is stuck as long as you make timely payments.  So the idea of an ARM is that the borrower takes on some of the market risk and in exchange for that, the lender can lend at a lower rate.  The terms you are seeking would, of course, be very attractive to the consumer.  But it severely heightens the risk to the lender.  Thus, if you found such a loan, it would not be priced anything like you are getting on the standard 7/1 ARM.

  • June 16 2014
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An ARM used properly is the best loan out there, but the key is used properly. My spreadsheets will compare a 30 year fixed with an ARM. If you can save the difference over 7 years then grow that difference in a tax free container that one loan will earn you say over 100k. I kid you not. Take the 7/1 ARM then refinance it in year 6 to 7 for another one. By then you will be out of that house I'm sure. If not take a fixed depending on rates. No one can predict rates. With global unrest and stupid elections going on all over the globe it's impossible. What you can do is control your economy. Save the difference and profit with an ARM. If you can't save the diff, take the fixed. 
  • June 16 2014
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I agree with Clay.  I think you are not getting the right info on years 8-12.    Plus that index is not currently 2.25%.  That is probably the margin.  The margin is added to the index at the time of adjustment in order to come up with the rate.  You may want to get some clarification on all of this so that you can make an educated decision.  A 7/1 ARM right now being almost a full percent lower that the 30yr fixed rate is something worth considering but you want to make sure you have all the facts to make and educated decision.  Happy to help if you would like to contact me through my profile
  • June 16 2014
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Typical caps are 2/2/5 or 5/2/5. The 5/2/5 cap means the rate could move up 5 points in year 8. The more common cap of 2/2/5 means you are capped at a 2 point increase in year 8, 2 more points in year 9, and a final 1 point increase in year 10. Of course those are all worst case. I have seen a 5 year arm with a cap of 2 points for the first adjustment that is good for 5 years but have not seen a 7/1 with a 2 point cap that is good for 5 years ( good through years 8-12 ). What you describe, a 2 point cap for years 8 - 12, would be very rare if it even exists. Ask your loan officer to email you the Arm verbiage so you can read it.  
  • June 16 2014
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