From: paul@hsh.com
Newsgroups: misc.consumers.house
Subject: Re: variable rate loan.
Date: 16 Dec 92 22:29:08 GMT
Organization: HSH Associates

In article <ByuKCB.H9p@jfwhome.FUNHOUSE.COM>, jfw@jfwhome.FUNHOUSE.COM (John
F. Woods) writes: 
> 
> A typical arrangement for a variable-rate loan is that they can change the
> rate by as much as 2% each year, sometimes with a lifetime cap of 6% over
> the period of the loan, sometimes with no limit to the increase (be careful!);
> Sometimes the rate will be pegged to some indicator, sometimes it will be
> whatever they think they can gouge you for (in fact, it usually is this,
> since the offset from the official indicator will be high enough that they
> can set the rate to what they like).  

Excuse me, but I think you're confused.  You're making it sound like "they"
have complete control over the interest rate.  Sorry, but it just ain't so. 
Federal law dictates that the ARM be tied to "an index which is beyond the
direct control of the lender" -- that is, a lender can't use his own prime
rate or some such as an index.  It must be an *outside* index.  And, if you
can find an ARM with no ceiling rate, I'd be very, very surprised.  We
haven't seen one since, oh, 1984. 

> So, you can probably assume that the
> "4.8%" loan they are offering here is really 4.8% this year, 6.8% next year,
> 8.8% the year after that, and 10.8% forever until rates fall back below
> 8.8%.  With the fixed costs of refinancing, they can keep a variable-rate
> loan about 2% above the going rate for 30-year fixed mortgages.

Yes, there is a margin added to the index value.  At each rate adjustment, 
it's Index + Margin = ARM Rate (subject to the annual cap).  And yes, I agree
that with an average margin of 2.75%, the interest rate will rise to the 2%
cap the FIRST time it's adjusted.  After that, however, the ARM borrower gets
the market rate (again, subject to the cap) -- it will not necessarily ALWAYS
rise.  In addition, most ARMs have a "ceiling" rate of 6% over the initial 
interest rate.  It's incorrect to claim that "they" will jack the rate as
high as possible "forever" -- and incorrect that "they can set the rate to
what they like". 

> And a further gotcha is that sometimes the rate they advertise isn't the 
> real first year rate -- after the first year, the rate rises to the "real"
> beginning rate of (say) 6.8%, after which they can raise the rates by
> another 6%.  On top of that, they will sometimes also require you to make
> up the difference in rate on that first year.

Again, you're confused.  See above.

> The key things to find out are (1) what's the scheme for rate increases,
> and (2) what's their limit on early payment of principal (I seem to recall
> that California allows lenders to really gouge you for early payments).
> 
> Also beware of variable-rate mortgages that offer a "payment cap" rather than
> a rate cap:  the lender can offer to limit the monthly payment at some amount,
> but if interest rates climb higher than what that payment will cover, they
> use your payment to cover interest *first*, thus keeping the principal from
> being paid off as fast as you expect, and if rates rise enough, adding unpaid
> interest to the principal.  

True enough.  ARMs that have monthly RATE adjustments, and annual PAYMENT 
adjustments, are a real bane.  Under these "monthly ARMs," you can end up 
owing MORE at the end of the year than you borrowed!

> Adjustable rate mortgages can be a real snake pit.  Be careful.

Yes, they can, but only if you don't know exactly how they work.

------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ 

Paul Havemann, VP        HSH Associates           (201)838-3330 | 1-800-UPDATES
      The Nation's Largest Publisher of Mortgage Information
Internet: paul@hsh.com   Compuserve: 70410,3507   America On-Line: HSH Assoc
Newsgroups: misc.consumers.house