Adjustment Frequency

  

You own an adjustable rate mortgage. It stipulates that you'll pay LIBOR plus one percent, or one hundred basis points. Your first six months are guaranteed to be at 4% max interest rate. After that, the rate adjusts every six months, such that no adjustment can be more than 25 basis points.

Inflation grabs hold of the planet and LIBOR skyrockets, going from 3% to 7% almost overnight. Luckily for you, you have an adjustment frequency tax of 25 basis every three months, so that next quarter you'll pay 4.25%, and the following quarter 4.5%, and the following quarter 4.75%, and so on...until eventually, years down the line, you catch up to the very expensive 8% interest you'll owe with LIBOR having settled in at 7%.

Adjustment frequencies are a core element of adjustable rate mortgages so that borrowers don't feel the rocking shocks of a volatile financial world where the cost of renting money is dancing around like a cat on a hot tin roof.

Related or Semi-related Video

Finance: What is Adjustable-Rate Mortgag...17 Views

00:00

Finance allah shmoop What is adjustable rate mortgage or arm

00:08

Well here's an arm and here's a leg and that's

00:11

What Renting the money to buy a home costs you

00:14

Yeah Okay Eight r m stands for adjustable rate mortgage

00:17

The rate well that's The interest cost of the money

00:20

or the cost of renting that money to buy the

00:23

home Well the rate isn't it fixed in this case

00:26

like five point seven percent for thirty years Where you

00:28

know in advance that your monthly payments going to be

00:31

nine hundred forty three bucks a month or whatever it

00:33

is that would be a fixed mortgage a fixed number

00:37

You can count on it for all three hundred sixty

00:40

payments And then the house is all yours So that's

00:43

fixed then what's adjustable like yes the interest rate changes

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But how does it change Well in a standard arm

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there is some global standard on which the rates are

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often price like lie bore the london interbank borrowing offering

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rate It's one of the key things that price is

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the cost of renting money all around the world with

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the actual rate of libel or is generally reserved for

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banks like super cheap cost of renting money to banks

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who are very likely to pay back the money with

01:11

no hassle that rate is more or less what banks

01:14

pay for running the money along with blue chip customers

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in real life The banks then mark up a premium

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on top of the rate that they're paying to rent

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the money to themselves And then they resell or re

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rent that money teo their prized customers So the pricing

01:30

of bank my views in renting money to joe six

01:33

pack could be something like lie boer plus three percent

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or three hundred basis points So if libel or is

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it didn't say two and a half percent today the

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adjustable rate might be five and a half percent and

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all that's great honor given alone It might mean that

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for a while you're paying seven hundred twelve dollars a

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month for your house payment wonderfully cheap and in fact

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banks market these low rates initially to help people be

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able to afford tto by that new home and live

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of the dream You know the american dream usually with

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an arm there's a teaser rate that starts really low

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Like at live or live or plus ten basis points

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or something like ridiculously cheap for six months or a

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year something like that Then it has an incremental set

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of step ups in interest costs and venit adjust with

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the markets usually upward maybe upward by a lot Remember

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there's a reason it's called a teaser rate but then

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if we get inflation or a you know just bank

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nervousness for there are weird effects from brexit or the

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volume of transactions going through london or something weird happens

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Well then the liquidity drops and interest rates rise So

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now lie board goes up and up and up to

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four and a half percent and wealth contractually in your

02:50

mortgage paperwork you have to pay live or plus three

02:53

hundred basis points no matter what So now that's seven

02:56

and a half percent interest on the dough you borrowed

03:00

and well we're that toe happen It's likely that your

03:02

monthly payment has skyrocketed from seven hundred twelve dollars a

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month is something more like twelve hundred dollars a month

03:09

or more Can you handle that big of a payment

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Well have you done a fixed rate loan at nine

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Hundred forty three dollars a month Well you'd still be

03:15

paying on that number but you rolled the dice with

03:18

an arm and now you owe big bills There go

03:22

that arm and a leg thing we warned you about 00:03:26.033 --> [endTime] eh

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