Florida Real Estate Broker ExaminationReal Estate Finance and InvestmentMedium
A Florida real estate broker is advising a client on investing in a property with a high amount of leverage. The client is concerned about the potential for negative cash flow if interest rates rise significantly. Which clause could be included in the loan agreement to mitigate this specific risk?
- AInterest rate cap
- BDue-on-sale clause
- CPrepayment penalty clause
- DEscalation clause
Show answer & explanationAnswer & explanation
Correct answer: A. Interest rate cap
An interest rate cap is a provision in an adjustable-rate mortgage (ARM) that limits how much the interest rate can increase over a specified period or over the life of the loan, directly addressing the client's concern about rising interest rates.
Why the other options are wrong
- B. A due-on-sale clause requires the loan to be paid in full upon the sale of the property.
- C. A prepayment penalty clause charges the borrower a fee for paying off the loan early.
- D. An escalation clause allows the lender to increase the interest rate under certain conditions, which would worsen the client's concern.
Interest Rate Cap
A provision in an adjustable-rate mortgage (ARM) that limits how much the interest rate can increase over a specified period or over the life of the loan.
- Protects borrowers from sudden and significant increases in monthly payments.
- Can be periodic (per adjustment) or lifetime (over the loan's term).
- Often a trade-off for a lower initial interest rate.
Memory trick: Cap: Keeps the rate from climbing too high, like a lid on a pot.