Adjustable-Rate Loan Terms

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Adjustable-Rate Loan
A broad term for a loan (mortgage or deed of trust) with rates and terms that can change. The Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, the Comptroller of the Currency, which regulates national banks, and the Office of Thrift Supervision, which governs federal savings and loan associations, have issued guidelines allowing the issuance of real estate loans having provisions to increase or decrease the rate of interest at certain time intervals (e.g., every six months) within a certain range (e.g., 1 percent).
The adjustable-rate loan has become commonplace, with allowable ranges as to time intervals, percentage of increase or decrease and total increases or decreases likely to change as market conditions change. (See biweekly payment loan, cap.)
The adjustable-rate loan has created its own glossary of terms, such as the following:
Current index: The current value of a recognized index as calculated and published nationally or regionally. The current index value changes periodically and is used in calculating the new note rate as of each rate adjustment date.
Fully indexed note rate: The index value at the time of application plus the gross margin stated in the note.
Gross margin: An amount, expressed as percentage points, added to the current index value on the rate adjustment date to establish the new note rate. The gross margin is stated in the loan document.
Initial rate: The below-market rate charged for the first adjustment period to attract borrowers (the “teaser rate”).
Initial rate discount: The index value at the time of loan application plus the gross margin minus the initial note rate.
Life of loan cap: A ceiling that the note rate cannot exceed over the life of the loan.
Note rate: The rate that determines the amount of annual interest charged to the borrower. The note rate is also called the accrual rate, contract rate, or coupon rate.
Payment adjustment date: The date on which the borrower’s monthly principal and interest payment may change.
Payment cap: A limit on the amount of increase in the borrower’s monthly principal and interest at the payment adjustment date. This takes effect if the principal and interest increase called for by the interest rate increase exceeds the payment cap percentage. This limitation is often at the borrower’s option and may result in negative amortization.
Payment rate: The rate at which the borrower repays the loan. This rate reflects buydowns or payment caps.
Periodic interest rate cap: A limit on the increase or decrease in the note rate at each rate adjustment, thereby limiting the borrower’s payment increase or decrease at the time of adjustment.
Rate adjustment date: The date on which the borrower’s note rate may change.
Subsidy buydown: Funds provided, usually by the builder or the seller, to sweeten a selling price by temporarily reducing the borrower’s monthly principal and interest payment.

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