Mortgage Refinancing - Rate Caps Protect You When Refinancing With an Adjustable Rate Mortgage

by Louie Latour - Date: 2007-01-24 - Word Count: 334 Share This!

Adjustable Rate Mortgages can save you money when mortgage refinancing if you fully understand how they work and limit your risk when borrowing. Adjustable Rate Mortgage loans come with built in safety features to help you avoid payment shock when mortgage rates change. Here are several tips to help you protect yourself from payment shock and minimize your risk when mortgage refinancing with an Adjustable Rate Mortgage loan.

There are two types of caps you need to concern yourself with when refinancing with an Adjustable Rate Mortgage. The types of caps are adjustment caps and lifetime caps and can be found in your loan contract. Caps protect you from swings in your mortgage rate while protecting the lender from having to foreclose because you can no longer afford your mortgage payment. Here is an example of how rate caps protect homeowners from payment shock when their lender resets the loan.

Suppose you refinance your mortgage with an Adjustable Rate Mortgage at 5.5% based on the one year Treasury Index. At the end of your introductory period the lender will reset your loan to the index and add a margin of 2.5%, raising your interest rate to 7.5%. Your monthly mortgage payment is now based on an interest rate of 7.5%. What happens if the one year Treasury Index has gone up to 10%? With the lender's margin your mortgage rate is now a whopping 12.5%! The payment on a $200,000 would effectively jump from $1,135 to $2,134.

Lucky for you, your Adjustable Rate Mortgage includes periodic and lifetime caps. Thanks to these caps your mortgage rate cannot increase more than 2 percent higher than the starting rate per adjustment. No matter how high interest rates climb you're still protected with the caps. Lifetime caps limit the amount your mortgage rate can change over the life of loan. This cap is commonly 5-6% over the life of the mortgage.

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