What features of an adjustable-rate mortgage will affect its cash flow?

What will be an ideal response?

For an adjustable-rate mortgage (ARM), as the name implies, the note rate changesover the life of the loan. The note rate is based on both the movement of an underlyingrate, called the index or reference rate, and a spread over the index called the margin.

The basic ARM is one that resets periodically and has no other terms that affect themonthly mortgage payment. Typically, the mortgage rate is affected by other terms. Theseinclude
(1) periodic rate caps and (2) lifetime rate cap and floor. A periodic rate cap limitsthe amount that the interest rate may increase or decrease at the reset date. The periodicrate cap is expressed in percentage points.Most ARMs have an upper limit on the mortgagerate that can be charged over the life of the loan. This lifetime rate cap is expressed in termsof the initial rate. ARMs may also have a lower limit (floor) on the interest rate that can becharged over the life of
the loan.

A popular form of an ARM is the hybrid ARM. For this loan type, for a specified numberof years (three, five to seven, and 10 years), the note rate is fixed. At the end of the initialfixed-rate period, the loan resets in a fashion very similar to that of more traditionalARM loans.