What may result from a payment cap on an ARM?

What may result from a payment cap on an ARM?

• A. Elimination of monthly payments
• B. Negative amortization
• C. Fixed interest rates
• D. Increased equity

Answer: (B)

A payment cap on an adjustable-rate mortgage (ARM) limits the maximum amount a borrower can pay each month regardless of the changes in interest rates. While this can provide short-term relief for borrowers, it can also lead to negative amortization. This occurs when the capped monthly payment is insufficient to cover the accruing interest on the loan. As a result, the unpaid interest gets added to the principal balance, increasing the overall amount owed. Over time, this can significantly increase the debt burden for the borrower, as they are not making progress on paying down the loan balance. To clarify the context of the other options: eliminating monthly payments would not be a feature of a payment cap, as borrowers are still required to make payments. Fixed interest rates are typically not associated with ARMs, as these loans are designed to have varying rates tied to market indices. Lastly, a payment cap usually does not lead to increased equity; instead, it can hinder equity growth since the loan balance may increase rather than decrease over time. Understanding how payment caps function helps borrowers evaluate the potential long-term implications of such mortgage features.

A payment cap on an adjustable-rate mortgage (ARM) limits the maximum amount a borrower can pay each month regardless of the changes in interest rates. While this can provide short-term relief for borrowers, it can also lead to negative amortization. This occurs when the capped monthly payment is insufficient to cover the accruing interest on the loan. As a result, the unpaid interest gets added to the principal balance, increasing the overall amount owed. Over time, this can significantly increase the debt burden for the borrower, as they are not making progress on paying down the loan balance.

To clarify the context of the other options: eliminating monthly payments would not be a feature of a payment cap, as borrowers are still required to make payments. Fixed interest rates are typically not associated with ARMs, as these loans are designed to have varying rates tied to market indices. Lastly, a payment cap usually does not lead to increased equity; instead, it can hinder equity growth since the loan balance may increase rather than decrease over time. Understanding how payment caps function helps borrowers evaluate the potential long-term implications of such mortgage features.