What will be the interest rate on the first adjustment for a 5/1 ARM with an initial rate of 3.25%, a cap structure of 2/1/2, given an index of 3.0% and a margin of 2.5% at adjustment time?

What will be the interest rate on the first adjustment for a 5/1 ARM with an initial rate of 3.25%, a cap structure of 2/1/2, given an index of 3.0% and a margin of 2.5% at adjustment time?

• A. 5.5
• B. 6.25%
• C. 4.25%
• D. 5.25%

Answer: (D)

In an ARM, the rate after the first adjustment is based on the current index plus the margin, but it’s limited by caps. Here, index + margin = 3.0% + 2.5% = 5.5%. The first adjustment cap is 2 percentage points above the initial rate, and the lifetime cap is 2 percentage points above the initial rate as well. The initial rate is 3.25%, so the maximum allowed after the first adjustment is 3.25% + 2.0% = 5.25%. Since 5.25% is the lower of the caps and the fully indexed rate would be 5.5%, the first adjustment rate must be 5.25%.

In an ARM, the rate after the first adjustment is based on the current index plus the margin, but it’s limited by caps. Here, index + margin = 3.0% + 2.5% = 5.5%. The first adjustment cap is 2 percentage points above the initial rate, and the lifetime cap is 2 percentage points above the initial rate as well. The initial rate is 3.25%, so the maximum allowed after the first adjustment is 3.25% + 2.0% = 5.25%. Since 5.25% is the lower of the caps and the fully indexed rate would be 5.5%, the first adjustment rate must be 5.25%.