Florida Real Estate Sales Associate Examination Content OutlineReal Estate Contracts and AgencyEasy
A borrower is applying for a mortgage to purchase a home. The lender offers a loan with an initial interest rate that is fixed for the first five years, after which it will adjust annually based on a specified index plus a margin. There is also a cap on how much the interest rate can increase or decrease per adjustment period and over the life of the loan. What type of financing instrument is being described?
- AA reverse mortgage
- BA fixed-rate mortgage
- CA balloon mortgage
- DAn adjustable-rate mortgage (ARM)
Show answer & explanationAnswer & explanation
Correct answer: D. An adjustable-rate mortgage (ARM)
An adjustable-rate mortgage (ARM) is characterized by an initial fixed-rate period followed by periodic adjustments to the interest rate based on an index plus a margin, often with caps on how much the rate can change.
Why the other options are wrong
- A. A reverse mortgage allows homeowners, typically seniors, to convert home equity into cash payments, which is unrelated to the described interest rate structure.
- B. A fixed-rate mortgage has an interest rate that remains constant for the entire loan term.
- C. A balloon mortgage requires a large lump sum payment at the end of the loan term, rather than describing the interest rate structure.
Adjustable-Rate Mortgage (ARM)
A type of mortgage loan where the interest rate is not fixed for the entire term of the loan. Instead, it fluctuates periodically based on an underlying economic index, typically after an initial fixed-rate period, and usually includes caps on rate changes.
- Interest rate changes over time.
- Rate tied to an index (e.g., SOFR, CMT) plus a margin.
- Often has an initial fixed-rate period (e.g., 3/1, 5/1 ARM).
- Includes periodic and lifetime interest rate caps.
Memory trick: Rates can be fixed forever or adjust with the market.