The interest rate on an adjustable rate mortgage can change in many different ways.
Interest Rate Adjustments
An adjustable interest rate is based on:
the lender's margin
the index value
the lifetime loan cap
rate adjustment cap
rate change interval
The lender margin
The lender's margin is the lender's profit, built on top of the cost of borrowing money for them.
The cost of the money in theory is the index. This index is usually based on a third-party index such as the LIBOR index. The index is a publicly available index that is not determined by the bank but by other parties. This keeps the bank from arbitrarily changing the index. The indexes are often common between different banks because they represent different interest rate indexes. The monthly payment is usually the index plus the margin.
The lifetime loan cap is the maximum interest rate allowed on the loan ever. This can be an absolute cap, meaning that even if the index skyrockets the interest rate payment does not. This is protection for the borrower.
An increasing adjustment cap is the maximum change in interest rate at any one time
A rate change interval is the time frame that the interest rate remains the same and changes at the end of the period. For example, a 6 month period means that the interest rate changes only once every 6 months.
An interest rate floor is the minimum interest rate on the loan. This protects the lender in case interest rates become very low.
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